Inflation And Deflation And Their Impact On Forex Trading

Last Updated July 23rd 2021
7 Min Read

The forex market is full of uncertainties and economic changes, with inflation and deflation being two monetary phenomena that affect the trading world.

Understanding the effects of inflation and deflation on your financial endeavours is crucial to establish a successful trading strategy and conquer the forex industry. We at Trading Education are here to guide you through your forex education journey.

Also, do not hesitate to sign up for our free forex trading course that will give you a start in forex trading.

Inflation And Deflation And Their Impact On Forex Trading

What Is Inflation and Why Is It Important in the Forex Industry?

The forex market, considered the largest financial market in the whole world, is marked by different fluctuations and economic conditions, such as inflation and deflation. 

Inflation is an indicator that shows the rate with which prices of goods and services increase in an economy. With the increase in prices, a currency can buy less than it did before and its purchasing power decreases.  

We should note that inflation can be divided into three categories (demand-pull, cost-push, and built-in inflation); two of the common indexes to express inflation are the Consumer Price Index (CPI) and the Wholesale Price Index (WPI)

  1. Demand-pull inflation happens when the demand for goods is higher than a country’s production capacity. Also, it can happen when there’s a rise in the money supply or devaluation of a country’s currency.
  2. Cost-push inflation is a phenomenon that happens when an increase in production costs occurs, including labour costs.
  3. Built-in inflation, on the other hand, is based on expectations and the so-called wage-price spiral. When prices rise, people expect more wages; when wages increase, costs also rise.

There is also hyperinflation when prices increase at an extremely rapid pace. Hyperinflation is often a result of war and social turmoil, with post-WWII Europe, particularly Hungary, being a clear example of hyperinflation.

Note that those who hold cash will be negatively affected by inflation, while those with assets, such as stock commodities, may benefit from inflation. It’s a country’s authority or central bank that should keep inflation levels within reasonable limits.


Inflation and Forex Trading

inflation and  forex trading

Due to the effect of inflation on a country’s currency, the exchange rates with other currencies also change. Note that this effect is often negative. Inflation is also linked to interest rates which influence exchange rates; experts claim that low interest rates rarely attract foreign investment.

If there is no demand for a currency, the desirability of buying and selling this particular currency will be low. As the perceived value of any fiat currency matters the most, a country with high inflation may still have a currency that is more desired in the trading world. However, inflation rates are not always comparable between countries. After all, it’s not a secret that fiat currencies have no actual intrinsic value as compared to gold. 

It’s not only inflation that has an impact on foreign investment and trading; a country’s political stability is also a crucial factor in forex, as well as its economic growth and debt levels.


What Is Deflation and Its Impact on Forex Trading?

Deflation is another economic problem that can affect the forex world. Deflation is defined as negative inflation or when inflation rates go below 0%. Deflation leads to a decrease in prices and an increase in the value of a country’s currency. Deflation can be caused by contractions of a country’s money and credit supply, a rise in productivity, or tight monetary policies. Also, deflation often happens after times of artificial monetary expansion. 

Interestingly enough, some of the most significant deflation crises in the world happened in the 30s in the US, in the 90s in Japan, and during the Great Recession in the US. Technological advancements today also affect the world economy, productivity, costs, and demand.

In fact, any changes in the global economy affect investment and trading. We should note that although deflation benefits consumers, it can also have a negative effect on the financial sector. An example that many economists give is borrowers who have to return money that is worth more than what they have borrowed. At the same time, deflation can benefit companies with high cash reserves and little debt.


Deflation and Forex Trading

deflation and forex trading

As stated above, deflation has a significant impact on a country’s economy. To provide an example, deflation can lead to a decrease in stock prices.

In the forex world, the circumstances behind deflation, as well as central banks, play a crucial role. For instance, if deflation is caused by low demand and poor profitability of businesses, a country’s currency may be devalued and foreign investors discouraged. 

Reflation, as the opposite of disinflation, can also happen. Here we should note that reflation is defined as the act of stimulating a country by increasing the money supply, decreasing interest rates, and applying tax cuts, especially after a period of a financial slowdown.

That’s why there’s no doubt that deflation is a moving force in forex. Interestingly, when trading USD/JPY and USD/EUR – two popular pairs – the fear of deflation may attract investments toward the dollar. Here you can learn more about different currency pairs, including exotic forex pairs.


How to Track Inflation and Deflation in Forex

There’s no doubt that inflation and deflation are two serious phenomena that can impact forex trading and other investment endeavours. Keeping track of news announcements and global data is essential to help you understand the effects of inflation and deflation on your forex trading strategy and goals.

  • Check different forex trading and central banks websites. Do not forget that central banks can control currencies directly.
  • Remember that it’s not only inflation rates that matter but also market news and expectations before the official release of data.
  • Do not forget that deflation and reflation also play a crucial role in forex trading.
  • Consider different factors that can affect the forex industry, such as politics, global trade, and social problems.


How to Trade Forex in Times of Inflation or Deflation

inflation and deflation in forex

Though the trading world is marked by constant changes, trading forex in times of inflation or deflation is possible. One of the main steps is to gain a deep understanding of the forex world.

  • Invest enough time in forex trading education and engage in different online seminars and forums. Do not forget that you can sign up for our free forex trading course here.
  • Do not hesitate to connect with other forex traders and learn from the best in the industry.
  • Whether you decide to trade forex part- or full-time, create an enjoyable trading routine and do not forget that maintaining a healthy lifestyle is crucial.
  • Depending on your goals, explore different options and trading strategies. Fear has no place in forex trading.
  • With time you should establish a consistent trading strategy because consistency is the key to success in forex
  • Keep track of different financial indicators, social issues, and news announcements as there are many factors that affect the world economy and forex trading.
  • When it comes to inflation and deflation, collect as much forex trading data as possible to stay ahead of the market.
  • Understand the importance of forex trading psychology and learn to control your emotions. Never trade out of greed or revenge.
  • Accept that the forex market is constantly changing, so losing is a part of the game. After all, winning and losing are two sides of the same coin.


Key Points

  • Forex, considered the largest financial market, is full of uncertainties and economic changes, but also financial opportunities.
  • Inflation and deflation are two phenomena in the world economy that have an impact on forex trading.
  • Inflation indicates the rate with which prices of goods and services increase in an economy.
  • Deflation occurs when inflation rates go below 0%; it leads to a decrease in prices and an increase in the value of a country’s currency. 
  • Interest rates, productivity, social problems, along with many other factors, affect forex trading in times of economic turmoil.
  • The perceived value of a country’s currency also plays a crucial role in forex trading.
  • Keeping track of news announcements and trading data, including market expectations, is essential to help you tame the forex industry.
  • Education, practice, consistency, and self-control are also needed to become a successful forex trader.

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The world economy is a maze of economic changes and fluctuations, such as inflation and deflation. To become a successful forex trader, one has to grasp all the international economic events out there, including exchanges of products, services, and currencies.

We at Trading Education are here to help you become a forex trading ace whose moves won’t be affected by today’s economic turmoil. Simply explore our website and sign up for our free forex trading course.

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