What Is Inflation and How It Affects Currencies

A hundred dollars over a year

What inflation does to money, and the route by which it reaches a currency. A hundred dollars kept for a year buys, at the end, what 98.0 bought at the start if inflation was two percent, 95.2 at five, 90.9 at ten. That is inflation: money buying less each year, measured by the basket in the consumer price index. The central bank's answer is the interest rate, raised when inflation is high and lowered when it is low, and the rate is what holding the currency earns. That is the route. Inflation makes the money worth less; the bank's answer makes the currency earn more; and on 14 July 2026 the minute the number landed moved the euro against the dollar 48.7 pips, where a pip is the fourth decimal place of the price.

An ice cube on a plate

Picture an ice cube on a plate, and a freezer beside it. The cube is the money, and it is smaller every hour it sits in the room; the room's warmth is inflation, and nobody can turn the room down. The freezer is the rate, and the bank turns it colder when the room is warm, so that money kept in the freezer holds its shape. A currency with high inflation is a cube in a warm room, and what the market watches is not the cube but the freezer dial, because the dial is what the bank will move, and the dial is what the currency earns.

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