The central link between inflation and market pricing

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The most important channel through which high inflation affects financial markets is interest rates.

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When inflation rises, central banks are typically forced to tighten monetary policy by raising interest rates or reducing liquidity. Higher interest rates increase discount rates used in asset valuation, directly affecting prices across financial markets.

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Expectations about future inflation are equally important. Markets react not only to current inflation data but also to signals about whether inflation will remain elevated. As inflation expectations rise, yields adjust upward, tightening financial conditions even before central banks act.

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This relationship makes inflation a key driver of market sentiment and pricing dynamics.