I'm trying to understand how different inflation trajectories between, say, the Eurozone and the US might influence $EURUSD beyond just interest rate differentials. Are there other significant channels to consider?
That's a great question, beyond rate differentials, purchasing power parity definitely comes to mind, even if it's more of a long-term concept. Do you think the market pays much attention to PPP in the short to medium term though?
This is a really interesting question. I've always focused on the rate differentials too, but it makes sense that actual purchasing power changes from CPI could have a direct impact. Could this lead to more subtle, longer-term shifts in trade balances that then feed back into the currency?
Beyond rate differentials, purchasing power parity (PPP) theories suggest that persistent inflation disparities should lead to exchange rate adjustments over the long term. Also, consider capital flows: higher inflation could deter foreign investment if returns are eroded, impacting demand for the currency.
Beyond interest rate differentials, you might consider the impact on trade balances and capital flows. Diverging CPIs can affect the relative competitiveness of exports and imports, and also influence investor sentiment towards different economies.