The linkage between Inflation and Forex
Traders in trading forex using fundamental analysis is the analysis of a news or economic and political events that can affect the condition of a country and its currency. Included in the inflation data. Then what is the relationship of inflation and forex?
Inflation or inflation data is often measured using the Consumer Price Index (CPI) data and this data is often awaited results when it is released. During one month of trading, the economic calendar is always full of data release schedules. Traders use the released economic data to interpret the economy.
When there are differences in economic conditions of the two countries then it could be the beginning of consideration of trading decision buy or sell pair currency. For example, if US data shows a stronger than expected market (analyst estimate), then trader will buy dollar. However, much data will be released in a month so that it can confuse the trader itself. Then, what is important for market participants?
The answer is what matters or the central bank’s consideration in making policy. Knowing the central bank’s consideration of achieving goals can help traders screen economic data.
Central banks around the world have a clear task. Most of the task is related to inflation. One of the central bank’s goals is to create or control inflation.
For an economy to grow normally, the inflation target should be in the 2% range. So the central banks of the world’s major economies are targeting inflation at 2% level.
The task of the central bank is to control inflation below or close to 2%. Any movement of the inflation rate down or away from the target then the central bank will take violation policy. Conversely, the movement of the inflation rate upward or close to or exceed the target then the central bank will take a policy of tightening.
The more inflation away from the target, the central bank will be more aggressive as needed. Core CPI data is often a reference for central banks and traders in interpreting the economy.