Effect of Inflation on the Stock Market | Motilal Oswal

Stock Market is Affected by Inflation

If you’re interested in online trading, it is important for you to know about the factors that influence the movement of the stock market. This will help you make better and more accurate trading decisions. One among the many key factors that influence the movement of the stock market is inflation. But then, what is inflation?  

It is essentially a macroeconomic indicator that’s widely used to measure the purchasing power of money. As the rate of inflation rises, the prices of goods and services in the economy will also rise. This will lower the purchasing power of money since each unit of currency would be able to purchase fewer units of goods or services. 

To put it simply, the higher the rate of inflation, the lower the purchasing power of money is and vice versa. Okay so, now that we’ve established what inflation is, let’s take a look at how it impacts the stock market.

How inflation affects the stock market? 

Inflation, as a factor, has an indirect impact on the stock market and its price movements. Check out the different ways in which it affects the markets. 

1. Lower revenue and profit figures impact the price of the stock

As you’ve already seen above, when the rate of inflation in an economy goes up, the purchasing power of individuals goes down. To counteract this, people generally tend to reduce their spending. Lower spending leads to lower revenue and profit margins for companies, which will ultimately culminate in their share prices going down. 

Additionally, the prices of raw materials and input services also tend to go up in a high inflation economy. This will also put pressure on the revenue and profit margins of companies, impacting the prices of their stocks in a negative manner.  

2. Rising interest rates make other asset classes more lucrative 

When the rate of inflation in an economy is high, the central bank of the concerned country generally tries to reduce the supply of money. This is done by raising the rate of interest, also known as the repo rate. When the rates are raised, borrowing becomes more expensive since it would mean that you would have to pay higher interest. And higher interest rates would dissuade people from spending, thereby reducing the supply of money in the economy. 

However, this act of the central bank also increases the rate of interest on other asset classes like fixed deposits, bonds, and other instruments. As these alternative asset classes become more lucrative, investors typically tend to move out of the stock market and invest in these kinds of assets, leading to a fall in the prices of stocks. 

Conclusion

As an increasing number of people prefer to save instead of spend during times of high inflation, the stock market participation will also be lower. This is another way in which the macroeconomic indicator affects the market as a whole. That said, if you’re someone who is interested in intraday trading or wish to start an SIP online, having a trading and demat account is mandatory. If you don’t have one already, reach out to Motilal Oswal immediately. You can open a demat account within just a few minutes for free. 

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