How does inflation affect stock prices?

Inflation in simplest terms is the sustained rise in overall price levels. For example, if a house was worth $1 million last year and inflation is 7% today, the same house will be worth $1.07 million. As inflation rises further, the same house would cost you even more.

Higher inflation is usually looked on as a negative sign for stocks because the central bank hikes interest rates on deposits and loans, so it increases borrowing costs, and input costs, and reduces standards of living. For companies, higher inflation reduces expectations of earnings growth, putting downward pressure on stock prices.

However, lower inflation is associated with lower interest rates in order to boost spending. The demand for shares grows as companies show strong revenues, and this results in share price appreciation.