How Does Inflation Impact the Stock Market?

Inflation

Stock market of Brussels
Stock market of Brussels (Photo credit: Wikipedia)

Inflation is defined as the constant increase of the price of goods and services.  For example, you will feel that inflation has increased when you are able to buy less of the same product now with the same amount of money than if you bought the product last year.  In short, inflation reduces your buying power.

How does inflation impact the stock market?

When there is a threat of increasing inflation, the country’s central bank intervenes by increasing interest rates.  Increasing interest rates encourages investors to move their cash to fixed income instruments. This decreases liquidity from the financial systems and which therefore decreases demand for goods in the economy, which in turn slows down the price increase of goods.

Higher interest rates works negatively for the stock market since it encourages investors to move their investments to less risky investments like time deposits or money market funds.  The less investments in the stock market causes lower demand for stocks causing lower prices of stocks.

The latest inflation number for the Philippines is at .8 as of July, this is down from 2.5 at the same time last year.

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