Inflation explained

What is inflation

Inflation is a general rise in prices across an economy over time. When inflation is positive, the same amount of rupees buys fewer goods and services than before. Its opposite, a general fall in prices, is called deflation. A slowdown in the pace of price rises is called disinflation. Prices are still rising during disinflation, only more slowly.

Inflation is measured with price indices. The best known is the Consumer Price Index (CPI), which tracks the cost of a fixed basket of household goods and services. Other measures include the Producer Price Index (PPI), which tracks prices that businesses receive, and the PCE price index, which the US Federal Reserve prefers. Each is covered in its own guide: Consumer Price Index, Producer Price Index and PCE inflation.

Causes of inflation

Economists usually group the causes of inflation into three types. In practice they often act together.

Demand-pull inflation

Demand-pull inflation happens when total spending in an economy grows faster than the economy can produce goods and services. Common drivers are:

• cheap credit and low interest rates, which encourage borrowing and spending
• large government spending or tax cuts (see Fiscal policy)
• strong growth in the money supply
• rising wages and employment, which raise household spending

When demand runs ahead of supply, sellers can raise prices without losing customers.

Cost-push inflation

Cost-push inflation starts on the supply side. Production becomes more expensive and firms pass the higher costs on to buyers. Typical sources:

• higher energy and fuel prices (see Oil and inflation)
• a weaker currency, which makes imported goods and raw materials more expensive
• supply disruptions, crop failures or shipping problems
• higher taxes on goods or regulated price increases

For an import-dependent economy such as Pakistan, a falling rupee and higher oil prices are classic cost-push channels.

Inflation expectations

Expectations are what households, firms and markets believe inflation will be in the future. They matter because they change behaviour today. If workers expect prices to keep rising, they ask for higher wages. If firms expect higher costs, they raise prices in advance. This can create a self-reinforcing cycle often called a wage-price spiral.

Central banks watch expectations closely through surveys and market prices, such as the gap between ordinary and inflation-linked government bond yields. Keeping expectations "anchored" is a large part of their job, and much of their communication, known as forward guidance, aims at this.

Headline vs core inflation

Headline inflation is the full index, including every item in the basket. Core inflation removes the most volatile items, usually food and energy, to show the underlying trend.

Headline inflation can jump because of an oil price spike or a poor harvest and then reverse. Core inflation moves more slowly. Central banks often give core figures more weight when deciding policy, because they are less likely to set rates in response to a temporary shock. Markets watch both, and a gap between them is itself information.

Why central banks target low, stable inflation

Most major central banks aim for inflation that is low and stable, not zero. Each sets its own numeric target or range; check the figure on the central bank's official website. Common reasons for a low but positive target:

• Stable prices help planning. Households and businesses can make long-term decisions without guessing at large price changes.
• A buffer against deflation. Falling prices can lead people to delay spending, which weakens the economy. A small positive target leaves room above zero.
• Measurement bias. Price indices tend to slightly overstate true inflation, partly because they miss quality improvements.
• Room to cut rates. Moderate inflation keeps nominal interest rates above zero in normal times, giving the central bank room to cut in a downturn.

The main tool is the policy interest rate. Raising it makes borrowing more expensive and cools demand; cutting it does the opposite. Some central banks also use asset purchases or sales (see QE and QT).

In Pakistan, the State Bank of Pakistan's Monetary Policy Committee sets the policy rate. The latest decision on our records: SBP policy rate raised by 50 bps to 12% with effect from 27.10.2026 (MPC). Check the current rate on the SBP's official website. More on this in SBP rates and economy.

Inflation and forex: how markets typically react

Inflation affects currencies mainly through expected interest rates. The general pattern, which does not always hold:

1. Inflation data comes in above expectations. Markets price a higher chance of rate rises, or fewer cuts. Short-term bond yields tend to rise and the currency often strengthens.
2. Inflation data comes in below expectations. Markets price a lower path for rates. Yields tend to fall and the currency often weakens.
3. Central bank tone matters. A hawkish reaction from policymakers to high inflation tends to support the currency. A central bank seen as falling behind inflation can see its currency weaken instead.

What moves markets is the difference between the actual figure and the consensus forecast, not the figure alone. This is explained in Economic surprises.

Some further points experienced traders watch:

• Real interest rates. The policy rate minus inflation is the real interest rate. A currency with positive and rising real rates tends to attract capital.
• Bond yields. Inflation data feeds directly into bond yields and FX.
• Gold. Gold is often discussed as an inflation hedge, but in the short term it usually reacts more to real yields and the US dollar. See What moves gold.
• Stock indices. Higher-than-expected inflation can weigh on indices if it raises rate expectations, especially for growth-heavy indices.
• Volatility around releases. Spreads can widen and prices can gap in the minutes around a major release. Stop orders may fill at a worse price than set.

Leveraged forex and CFD trading can lose money fast, and data releases are among the riskiest moments. Read Risk management before trading around news.

Where to find release dates and figures

Do not rely on unofficial sources for inflation dates or numbers. Release dates come from official calendars published by national statistics agencies and central banks, such as the US Bureau of Labor Statistics for CPI and the Pakistan Bureau of Statistics for Pakistan's CPI. Central bank meeting dates are published on each central bank's own website. An economic calendar collects these in one place; learn to use it in the Economic calendar guide.

For broader context, see Central banks and currencies and Fundamental analysis.

Frequent questions

What is inflation in simple words?

Inflation is a general rise in prices over time, so money buys less than it did before.

What are the main causes of inflation?

Strong demand relative to supply (demand-pull), higher production costs (cost-push), and expectations of future price rises that change wage and price setting.

What is the difference between core and headline inflation?

Headline includes all items in the basket. Core removes volatile items, usually food and energy, to show the underlying trend.

Why don't central banks aim for zero inflation?

A low positive target guards against deflation, allows for measurement bias, and leaves room to cut interest rates in a downturn.

How does inflation affect forex?

Through interest rate expectations. Figures above forecast often support a currency because markets expect tighter policy. Figures below forecast often weaken it. Reactions vary and are not guaranteed.

Does high inflation always make a currency stronger?

No. If markets believe the central bank will not respond, or if inflation hurts growth badly, the currency can weaken instead.

Where can I check official inflation figures for Pakistan?

On the Pakistan Bureau of Statistics website for CPI, and the State Bank of Pakistan website for policy decisions and statements.