Inflation to ease up in the coming six months ringing in good news for the markets. Here’s why

Easing up of inflation and its effect on the markets

 good news for markets

Inflation is defined as the increase in the price of goods and services and the consequent reduction of the purchasing power of money. As the purchasing power of money reduces, you need more money to buy the same goods and services. This increases your expenses and reduces the nominal returns from investments.

In India, inflation has been steadily increasing over the years. In 2020, the CPI (Consumer Price Index) stood at 4.59%, which increased to 5.59% in 2021 (Source- Even in 2022, the trend is continuing, becoming a bone of contention for investors as they lose out on their returns.

However, basis how inflation is measured, it is expected to ease up in the next six months. Let’s understand how.

The base effect in inflation

Inflation is measured using an index which comprises a specified basket of goods and services. The price of this index is measured every month. After that, the last year’s corresponding month’s index is compared to the current month’s index. For instance, the index of October 2022 will be compared with the index of October 2021.

The rate of inflation is the percentage increase in the current month’s index compared to the last year’s index. In other words, the increase in October 2022’s index over that of October 2021 will be the inflation rate.

This calculation shows that while the prices of goods and services of the current month determine the rate of inflation, the prices of last year also have an impact. This is called the base effect. Due to this base effect, if the last year's index is high compared to the current year, the inflation in the current year will be lower and vice-versa.

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The latest inflation data

The latest data is as follows –

  • CPI for August 2021 – 162.9
  • CPI for September 2021 – 163.2
  • CPI for October 2021 – 165.5
  • CPI for November 2021 – 166.7
  • CPI for September 2022 – 175.3

Since the change between August and September 2021 was minimal, the inflation in September 2022 is low due to the base effect. Though CPI for October 2022 is not yet declared, the inflation is expected to be low due to the positive base effect. Similarly, as the base effect remains positive, the inflation in November 2022 and in subsequent months is also expected to be lower.

The effect of muted inflation

As the inflation is muted, given the base effect, the markets might see a rally and investors can avoid inflationary pressure on their investment returns. So, till March 2023, the outlook is positive.

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