One of the most influential factors which affects our lives, is none other than the cost of living. Throughout recent years, it is unmissable how the changes in the cost of living have impacted various aspects of life, from the way we shop, down to our financial outlooks.
Among the many aspects that this affects, one area that’s strongly influenced by changes in the cost of living is the foreign exchange (forex) market.
When dealing with trading currency pairs, it’s essential that you address the current cost of living, and how it’s altering the market – and as an example, Plus500 explains what forex trading is in more depth if you wish to learn more about the market.
In order to gain a better understanding of this particular factor, let’s analyse the current cost of living crisis in the UK (as of 23rd March 2022), to see how it might be impacting the forex market.
With this information, you will have a much more extensive understanding of how the forex market’s moving, and can plan more accurate trades accordingly.
What is the is the cost of living?
The cost of living is determined by the level of expense needed to cover general living necessities. This will often include the price of food, housing, taxes, healthcare, and other general goods and services. Essentially, the cost of living is as it says – how much does it cost to live in a certain place?
This is calculated using a cost-of-living index. There are various indexes that can be used, but the basis of them often involves measuring the prices of certain goods and services in one area against another. This can range from a measurement of a city against another, to the measurement of a country.
In areas where the cost of living is high, it is expected that wages rise to meet it – and vice versa. However, a cost of living crisis can come about when the cost of living is high, and the average income of the area’s citizens is significantly lower.
This results in an increased rate of inflation. It can be easily comprehended, by viewing inflation as the amount of goods in a basket your currency can buy. Taking the Great British Pound (GBP) for example, as inflation rises, £1 will buy less goods in a shop than it did before.
As the UK is currently in its own cost of living crisis, it will be beneficial to look at how this is affecting the forex market.
How is the UK’s cost of living affecting forex?
At the time of writing, the UK has reached the highest rate of inflation that has been seen in 30 years, and now sits at 6.2% – the highest since March 1992 where it sat at 7.1%. In fact, the Bank of England predicts an increase to 8% in April, and a further rise to 10% in Autumn.
This massive increase in inflation is largely due to the invasion happening in Ukraine. As destruction and trade sanctions have largely cut down the UK’s energy imports, the wholesale price of gas in January 2022 was four times higher than that of early 2021. This is set to rise by a further 54% from April, which will add £693 to the average annual household bill.
Thus, the cost of living is on the rise, and the people of the UK don’t seem to have an income equipped to manage it. So, what has this meant for the forex market?
Inflation on the rise, and an unmanageable cost of living, is a sure way to bring a country’s currency value significantly lower.
As the cost of living has reached crisis level in the UK, it has heavily weakened the value of its currency. The value of the GBP has fallen rapidly, which can be seen comparing it against the value of the US Dollar (USD). On February 23rd, GBP began falling from $1.35, and steadily decreased to $1.30 on March 15th.
As a forex trader, it’s highly advisable to keep an eye on the cost of living in the UK, as the rate at which it’s rising, could mean further reductions in the value of the GBP.
However, Chancellor Rishi Sunak delivered a statement on March 23rd, detailing plans for managing the rising cost of living.
He hopes to focus on building a ‘stronger, more secure economy’, and improving the ‘security for working families’ to ‘help with the cost of living’.
As a forex investor, news like this could prove essential — if the cost of living crisis is tackled with successful, strategic approaches, then the UK’s currency value will reap the benefits.