Effect of Inflation

Discussion in 'Forex' started by scorlett, Apr 21, 2006.

  1. scorlett


    I am relativley new to the whole fx trading game and was wondering if anyone could answer me a question regarding inflation.

    Prequal - I only trade the AUD/USD. My current position is long at .7382.

    Next week in Australia when inflation figures are released it is expected that inflation is going to be higher than predicted. This of course will lead to an increase in interest rates. Which of these factors will the market react to first?

    Will the AUD decline because its purchasing power in the global market is seen as reduced or will the AUD appreciate in anticipation of an increase in interest rates (and concequently a large inflow of capital).

    Any help anyone could provide would be great?
  2. m22au


    1. CPI and PPI are not inflation figures. However for a variety of reasons, they are referred to as such.

    2. The AUD/USD (or any currency pair) move according to the wishes of buyers and sellers. They may not necessarily take into account the "inflation figures" when making these decisions.

    3. If it is "expected that inflation is going to be higher than predicted" appears to be a circular argument. i.e., if it is "expected that inflation is going to be higher than predicted", then to me, that becomes the prediction.

    4. Higher "inflation figures" do not necessarily lead to an increase in interest rates

    5. Notwithstanding the above, given that the RBA cash rate has been on hold for about a year, my thinking is that higher than expected "inflation" would send Aussie yields lower and the paper AUD higher against the paper USD.

  3. scorlett


    that really didnt answer my question. You state obvious assumption which I already understand. All I really want to know is that technically speaking would an increase in inflationary pressure be more likely to:

    - devalue the dollar cause its purchasing power on the global market is less


    - appreciate the dollar in anticipation of an interest rate increase

    or both (in what order)

    All other factors remaining the same.
  4. Higher interest rates will slow economic growth, reducing business and comsumer spending. Company profits will fall, so stocks will fall. A rise in interest rates relative to those in other countries will tend to result in an increase in the amount of funds flowing into the US, as investors are attracted to the higher rates of interest. This will tend to result in an appreciation of the exchange rate against other currencies. In practice, the exchange rate will be influenced both by expectations about future interest rates and any unexpected changes in interest rates. ThAt is because if investors expect interest rates to rise, they may increase the amount they invest in a currency before interest rates actually rise. So there is never a simple relationship between changes in interest rates and exchange rates.