Inflation
A general, lasting rise in prices that erodes money’s purchasing power.
2%
ECB and Fed target
10.6%
Euro area peak (Oct 2022)
9.1%
US peak (June 2022)
in 24 years
Prices double at 3% a year
Notitia
A general, lasting rise in prices that erodes money’s purchasing power.
Inflation is the general, lasting rise in prices. It is measured by the year-on-year change of a consumer price index (CPI in the US, HICP in the euro area), which tracks the price of a representative basket of household purchases: food, energy, housing, services, manufactured goods. Inflation of 3% means it takes 103 euros to buy what cost 100 a year earlier.
Three sources combine. Demand-pull inflation: when demand exceeds what the economy can produce, prices rise. Cost-push inflation: higher energy, commodity or wage costs pass through to selling prices. Expectations: if everyone expects 5% inflation, wages and prices are set accordingly and the prophecy fulfils itself. That is why central banks care so much about anchoring expectations around 2%.
Zero inflation is risky: indices slightly overstate true price rises, and an economy near zero easily slips into deflation, where households postpone purchases. High inflation erodes savings and blurs price signals. The ECB, the Fed and the Bank of England therefore aim at 2% over the medium term: enough to keep room for manoeuvre, little enough to protect purchasing power.
Inflation above target pushes central banks to raise rates: existing bonds lose value, growth stocks (whose profits lie far ahead) suffer, and the currency may strengthen. Conversely, falling inflation opens the door to rate cuts, which support bonds and valuations.
Result: a nominal gain of €300 but a real loss of about 1%.
After economies reopened and Russia invaded Ukraine, energy and food prices soared. Euro area inflation peaked at 10.6% in October 2022 and US inflation at 9.1% in June 2022, levels unseen since the early 1980s. The ECB lifted its deposit rate from -0.5% to 4% in fourteen months.
The HICP is the harmonised CPI, computed with the same rules in every EU country so they can be compared. It is the measure the ECB targets.
People notice frequent purchases (fuel, food), which swing more than the average, and every household has its own basket.
Notitia newsroom · education, not investment advice.