Inflation will play an important part in the financial market this week; influencing currencies, stocks, bonds and trading decision. Europe, England and USA are expected to release their inflation rate report.
Economist view inflation as a reduction in the purchasing power of a currency and it is measured as rate. The higher the rate at which prices of goods and services increases the higher the inflation rate can be.
Inflation rate is an economic indicator followed by economist, central banks and investor and could have an impact in the decision making process. Inflation rate can have a simultaneous positive or negative impact in the economy and therefore in investor’s portfolio.
Some of Inflation Possible Impact in The Economy.
- Discourage investment and saving.
- Import Shortages.
- Higher Exports.
- Diminish consumer confidence.
- Prices of goods and services increase.
- Lower currency exchange.
- Short term uneven income distribution.
- Capital expenditure at expenses of future earnings.
In general most economists favours low and steady rate of inflation and regards high inflation rates as prejudicial for the economy.
Inflation Rate Impact on Financial Markets
Bond market tent to rally when the Inflation Rate increases and vice verse. Equity market tent to rally when inflation is low as it could keep interest rates low.
Example for calculating inflation (ECB Sample)
Quantities bought in the base year
|Per unit||Total||Per unit||Total||Per unit||Total|
|150 loaves of bread||$1.50||$225||$1.30||$195||$1.60||$240|
|100 cups of coffee||$2.50||$240||$2.40||$240||$2.15||$215|
|1 winter jacket||$145.00||$145||$176.00||$176||$160.00||$160|
|Total cost of basket||$850||$875||$891|
1. List all the products in your basket and the quantities you consumed in a given year (this will be your “base year”).
In our example we take just bread, coffee, haircuts and a winter jacket.
2. Calculate the total expenditure for each of the products by multiplying the quantities purchased by the price you paid for them:
150 loaves of bread x €1.50 = €225
100 cups of coffee x €2.40 = €240, etc.
3. Add up the totals for all the products to get the total cost of consumption. In our base year it’s €850.
4. Repeat steps 2 and 3 for the following years.
Looking at the example you will see that, after the first year, some prices changed. The total cost of consumption has risen to €875. After the second year, it’s €891.
5. Divide the total cost of the basket in each subsequent year by the cost of the basket in your base year, then multiply the result by 100.
One year later: €875 ÷ €850 x 100 = 102.9
6. The annual rate of inflation is the percentage change from one year to the next.
In the example, after one year the inflation rate is 2.9%. This is calculated as the price index for that year minus the price index for the previous year (102.9 – 100), divided by the price index for the previous year (100) multiplied by 100. For the following year it’s (104.8 – 102.9) ÷ 102.9 x 100 = 1.8%.
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