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How Will Inflation Affect Currency Markets in the Coming Months?

Across all sectors of the news, inflation continues to dominate the agenda. A combination of supply chain disruption, soaring demand, and political instability have all combined to push inflation to its highest level in decades, with both developed and emerging economies feeling the pinch.

We have already seen how inflation is continuing to push prices up to record highs across virtually every market, with food, transport, and energy being particularly hard hit.

However, one story that is garnering relatively little attention is the impact of inflation on currency markets. Let’s take a closer look at how we can expect inflation to make its impact known in this area in the coming months.

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Inflation will continue to erode the value of cash
First off, it’s important to note that inflation is predicted to remain high throughout the year. Furthermore, some experts believe that we are actually far from the peak and that inflation rates have much higher to climb. What this means for virtually all currencies is that their absolute value will fall.

Inflation quite literally means that cash loses its value, as a single unit of that cash no longer pays for the same amount of goods that it used to. While exchange rates of currencies relative to others will vary, cash everywhere will continue to erode in value throughout the year.

Emerging currencies will be harder hit
It’s worth noting that not all countries have experienced inflation equally. Emerging markets are experiencing levels of inflation that would give policymakers in high-income countries nightmares. For example, Turkey and Brazil have been experiencing inflation in excess of 60% for months now. Compare this to a mere 7.5% for the Eurozone, and it’s clear who is getting it worse.

This will have the effect of eroding the value of emerging market currencies relative to other, wealthier currencies. As this guide to forex trading explains, minor pairs such as EUR/Turkish Lira are increasingly popular options in global forex markets.

If forex traders decide to bet against the Lira relative to the Euro, as inflation continues to pile on the pressure, this could make the situation even more severe, as wider market sentiment turns against the Lira and goes bearish. The risk of this happening with emerging market currencies in the coming months is high and should be watched closely.

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The Greenback will be a surprise winner
Inflation is currently battering the US economy. In normal times, this would erode the value of the dollar relative to other currencies. However, this time, that is not happening. Inflation is everywhere, leading to more negative sentiment globally. As such, investors and forex traders are flocking to the US Dollar, since this is the global reserve currency and widely considered to be a “safe haven” in times of turmoil.

Since inflation started spiraling up at the start of the year, the US Dollar has been on a constant rise and is now at its highest value relative to other currencies, such as the Euro, in more than 20 years. Expect this trend to continue apace as inflation runs rampant through the global economy.

Inflation is not going away, but that does not mean it will be allowed to run rampant. We are already seeing some concerted policy action from central banks around the globe, which could change the situation dramatically in the coming months. Only time will tell.

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