Inflation, interest rates and the gold price

Inflation, Interest Rates and the Gold Price Blackout © "Paul", CC BY 2.0;

Consumer prices have risen sharply in recent months, and the key interest rates of the major central banks remain close to zero. At 5.0 percent, the inflation rate in the USA is the highest it has been since 2008. And here in the EU, too, prices have risen more sharply than at any time in over a decade. But what does the price of gold have to do with inflation and interest rates?

What do inflation & interest have to do with the price of gold?

Gold is an excellent way to preserve value over the longer term. Although the precious metal does not yield any interest, it is a very safe investment because it can never completely lose its value. Historically, you always got a similar commodity value for an ounce of gold.

When interest rates are low, investments in other supposedly safe investments are not worthwhile, while investment opportunities that promise returns above the level of inflation are significantly riskier. Low interest rates therefore not only lead to a higher inflation rate, but also push up the price of gold.

However, if interest rates rise and push inflation down, investors can also earn money with their money in safe forms of investment. Therefore, low inflation and interest rate increases also usually cause the price of gold to fall.

Inflation is already here

In the USA, consumer prices have recently risen more sharply than at any time since the crisis year 2008. In the EU, the inflation rate also rose in 2021. For the euro zone, the ECB expects an inflation rate of 1.7 percent for the year as a whole.

In Austria, inflation in May was already 2.8 percent according to estimates by Statistik Austria, and as high as 3 percent according to the harmonized consumer index. This makes the price jump the biggest in more than 10 years. In Germany, too, prices recently rose by around 2.5 percent. This is also the highest value in 10 years.

Economists argue that energy prices in particular are responsible for the sharp rise in prices. However, the "basket of goods" used to measure price developments has been criticized for years.

Inflation: An Attack on Savings

For savers, however, inflation is pure poison. Because if everything becomes more expensive, the purchasing power of the hard-earned savings decreases. Without interest, the money in the account loses some of its value every day.

If inflation starts to get out of hand, the assets of ordinary citizens are in danger of melting away. Therefore, if you want to preserve your assets, you have little choice but to invest.

Because shares and securities are relatively risky, the only conservative part of the portfolio that often remains is "flight" into tangible assets. In addition to real estate ("concrete gold"), these are primarily precious metals.

Why do policymakers want inflation in the first place?

The primary objective of central banks is price stability. However, monetary policy is aimed at achieving slight inflation, i.e. price increases. The ECB, for example, wants prices to rise by an average of just under 2% per year.
Policymakers would rather have inflation than deflation. After all, if prices are rising steadily, companies and consumers would rather spend their money today than tomorrow. If, on the other hand, there is the prospect of goods and services becoming cheaper, consumers prefer to wait or companies hold back on investments. And that would put a massive brake on the economic cycle.

Interest rates: a monetary policy tool

To bring the inflation rate to the desired level, interest rates are one of the most common tools used by central banks.

If central banks lower key interest rates, it becomes cheaper to borrow money. Cheap loans are intended to encourage companies in particular to invest. This then creates a lot of money in the economic cycle and should lead to the desired inflation.

Since interest rates have now been close to zero or even below for more than a decade and inflation has nevertheless not been at the desired 2 percent, central banks have additionally tried and are still trying to "keep the economy going" by expanding the money supply ("quantitative easing" = printing money).

Is the interest rate turnaround coming?

The questions savers must now ask themselves is whether - now that the supposed "desired inflation rate" of 2% has been reached - the FED and ECB will raise key interest rates or the central banks will continue their current monetary policy.

In recent weeks, U.S. Treasury Secretary Janet Yellen has increasingly expressed her desire for interest rates to remain at a "normal level". The head of the Federal Reserve, Jerome Powell, however, wants to keep interest rates close to zero in order to continue providing US companies with cheap money.

And now that the 2% inflation target has been reached again for the first time in years, the ECB is unlikely to stifle this development by raising interest rates. This is also because many economists consider inflation of up to 4% to be harmless.

It is therefore more likely that the current monetary policy of cheap money will be continued.

For the gold price, this means that a further increase in the price can be assumed.

Hedge assets with gold

Defend your assets against devaluation! Gold is an excellent "economic self-defense" against inflation. With gold, even smaller assets can be easily hedged (not everyone can afford real estate), it is easy to transport and store.

With an investment in gold you are in any case always on the safe side! Due to its limited availability, gold has been a lasting value for many centuries. You can rely on that!

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