Inflation
The number that decides every rate decision
- Define inflation and explain why CBs target 2%
- Read CPI vs core CPI and know which the CB actually watches
- Predict FX reaction to a hot or cold CPI surprise
Inflation is the single most important number in modern macro. It decides whether your central bank hikes or cuts. Which decides your yield differential. Which decides — on most days — what your currency does next.
What inflation actually is
Inflation is the rate at which the average price of goods and services rises. Measured by CPI (Consumer Price Index) — a basket of stuff households buy. If the basket cost £100 last year and £103 this year, inflation is 3%.
Why central banks target 2%
Too low (or negative) = deflation, which freezes spending (why buy today if it's cheaper tomorrow?) and crushes debt-servicing economies. Too high = wage-price spirals, eroded savings, social unrest. 2% is the goldilocks zone — high enough to lubricate the economy, low enough to be invisible.
Everything in the basket including food and energy. Volatile because oil prices and weather swing it month-to-month. What politicians quote.
Strips out food + energy. **What the central bank actually watches** because it reflects the persistent, underlying price pressure they can affect with rates.
US CPI prints 3.2% vs 3.0% expected. USD likely reaction?
- Inflation = average rate of price rise (CPI)
- CBs target 2% — high enough to avoid deflation, low enough to be invisible
- Core CPI (ex food/energy) is what the CB actually watches
- Hot CPI → hawkish CB → currency stronger
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