The rate of inflation in the UK is constantly discussed in the media, with this having a direct impact on the overall cost of living on these shores.
Most recently, the rate of inflation in the UK picked up considerably in March, as global oil prices rose and retailers finally began to scale back their Covid-driven discounts. More specifically, consumer price inflation rose to 0.7% in March, after a temporary dip to 0.4% during the previous month.
But what exactly is inflation, and what relationship does it have with a country’s base interest rate.
What is Inflation?
In simple terms, inflation refers to the rate at which the prices of goods and services increase within the national economy.
As we’ve already touched on, rising inflation means that you have to pay more for the same goods and services, which in turn can translate into a higher cost of living over time.
This is why an extended period of high or rising inflation can be economically damaging, as the cost of living rises and your income fails to keep pace with this. This has been a significant issue amid stagnant real wage growth in recent times, creating a scenario where each household’s buying power declines and economic growth begins to dwindle.
However, the precise economic impact of inflation depends primarily on the type of inflation that’s prevalent. For example, so-called “walking inflation” tends to demonstrate a variable rate of between 3% and 10%, triggering rapid economic growth that simply cannot be sustained by average earnings.
The most common type of inflation is referred to as “creeping” or “mild” inflation, which refers to instances where prices rise 3% a year or less. This can be beneficial to the economy in most instances, especially if wages continue to increase incrementally during the same period.
Then come ‘galloping’ inflation and ‘hyperinflation”, the former of which refers to a rate in excess of 10%. As for hyperinflation, this is where the rate of inflation extends beyond 50%, with this issue having most recently engulfed the Central American country of Venezuela.
Exploring the Relationship Between Inflation and Interest Rates
If you’ve ever traded forex through the MT4 platform, you’ll know that interest rates have a direct impact on the value of currency and pairs across the globe.
However, did you also know that base interest rates and the rate of inflation enjoy an inverse relationship, which is why the former is often used as a quantitative easing measure to help control and manipulate the latter for the good of an economy.
In simple terms, the maintenance of low interest rates can help to stimulate economic growth and cap inflation, where soaring interest rates are known to curb economic expansion and are synonymous with low or mild inflation levels.
In this respect, both inflation and interest rates remain key metrics for forex traders, with these core macroeconomic elements influencing price fluctuations on a daily basis.
This is why it’s important to monitor their performance in real-time, while using an economic calendar to ensure that any future trends and changes can be identified ahead of time.