Simply put, inflation is the average price change of prices of goods and services over a given period of time. It shows a decrease in the currency’s buying power.
Again, the central bank of every country will intervene in many ways depending on the status of inflation and this intervention will also have a corresponding influence in the forex market. For instance, when there is very high inflation, people will not be motivated to save money. Rather, they would look for opportunities to spend money on or buy assets before the value of their currency falls even further. So central banks will increase their interest rates to encourage people to save more. Now this increased rate will increase the demand for the bonds of that country. That would translate into increased demand for the currency of that country. When the demand for a country’s currency goes up, its value also climbs in the forex market.
The reverse happens when there is a decrease in inflation. Central banks will cut interest rates to encourage lending and thus pump more money into the economy. This will reduce the demand for the country’s bonds and thereby the demand for the currency. This will pull the value of currency down in the forex market.
The Bottom Line
The currency rates fluctuate depending on central banks’ monetary policy. Therefore, a smart forex trader will always keep themselves abreast of the latest news releases. This will help prepare and prevent any surprise price fluctuations, which in turn will help maintain a consistent winning score in trades.