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– Data matters only through the policy response it is expected to trigger
– The same inflation print can be bullish or bearish depending on the central bank’s stated priorities
– Watch which variable the committee says it is watching, and track that variable
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There is a persistent assumption in retail macro analysis that higher inflation means higher rates, which means a stronger currency. The chain is real, but each link can break, and the market prices the whole chain rather than the first item in it.
The reaction function is the missing variable
A central bank’s reaction function is simply the rule connecting what it observes to what it does. Some committees have signalled that they will look through supply-driven price increases. Others have signalled that they will respond to any deviation from target. Some are explicitly focused on labour market conditions and treat inflation as a lagging confirmation. The identical inflation figure produces opposite currency outcomes across those three regimes.
This is why reading the statements and speeches matters more than reading the data. The committee tells you, in fairly plain language, what it is weighting. Track that variable and you can anticipate the response rather than react to it.
Why the reaction can be inverted
Consider a case where inflation surprises sharply higher but the market concludes that policy is already restrictive enough and that the surprise raises the probability of a hard landing. Front-end yields might rise slightly while long-end yields fall and equities sell off. In that configuration a currency can weaken on hot inflation, because the market is pricing damage rather than tightening.
The reverse also happens: a soft inflation print that raises confidence in a soft landing can strengthen risk currencies even as rate expectations fall, because growth expectations improve.
Composition beats the headline
Central banks care about persistence. Price increases driven by volatile components tell them little; price increases in services, where wages dominate the cost base, tell them a great deal. This is why market reactions are sometimes muted after a large headline surprise and violent after a small one — the composition determined whether the print changed anyone’s view of persistence.
Practical process
- Read the most recent policy statement and identify the variable the committee says it is prioritising.
- Before a release, note not just the consensus but where the market is positioned, since that determines the asymmetry of the reaction.
- After a release, check the front-end yield response before drawing a conclusion from spot. If the currency moved but yields did not, the move is unlikely to persist.
Full release schedules, consensus figures and previous readings are on our economic calendar.