Inflation expectations, or the pace at which consumers, companies, and investors expect inflation to grow in the future, are crucial indications of prospective macroeconomic developments. Household inflation expectations are important components of Keynesian economic models, but their influence also extends to financial markets.
When these expectations are realised, stock market reactions have typically been shown to be a little skewed. The stock markets, on the other hand, are unable to respond to unexpected increases in inflation. As a result, many experienced investors watch for indicators of growing inflation.
Early Warning Signs of Inflationary Expectations
It’s worth noting that these forecasts are mostly based on previous inflation data. For example, if central banks pursue a policy of keeping interest rates low, most consumers will lower their inflationary expectations. However, if additional capital inflows are encouraged by government actions, these expectations will rise.
In the same way, evidence of economic recovery is an indicator of rising inflationary expectations. As the economy picks up, people become more hopeful. When seen from a macro viewpoint, this optimism pours into their purchasing patterns, which influence the economy’s trajectory.
On the Verge of Recovering and Growing
Since the epidemic began last year, most economies throughout the world have been in or near the last stages of recovery. Australia boasts of effectively completing its recovery phase and aspires to return to pre-pandemic economic activity levels.
With favorable government policies as a backdrop, this period represents the beginning of growing inflation expectations. People’s confidence for the future days is bolstered by increased liquidity offered by fiscal and monetary policy. People have a greater sense of confidence as economic indicators such as employment improve, allowing them to shift their focus from savings to spending.
Stock Market Reaction
Stock markets should be wary of rising inflation predictions. Most businesses dislike the concept of raising pricing. The probability of future inflation signals increased capital expenses for the business sector. This is why inflationary forecasts have minimal impact on stock prices.
Stock markets may be difficult to understand since there are so many moving pieces, especially when there are so many different sorts of corporations engaged. Investors and consumers adapt their expectations as inflation indicators shift. This changes their purchasing and selling habits. As a result, while examining stock markets, expectations must be considered.
Historical evidence also implies that when inflation happens during a recession, the stock market reacts more forcefully than when it occurs during a boom or expansion. Businesses may be able to recoup their inflation-related losses by making bigger earnings during an expansionary phase. Firms, on the other hand, are bound between diminishing profitability and inflationary pressure during the contractionary phase of the business cycle.