Relationship Between Inflation & Stock Market Performance In UK

Introduction Of The Relationship Between Inflation And Stock Market Performance In The Uk: An Empirical Analysis

The term inflation is a broader concept emphasizing a gradual increase in prices across the entire economy. The increases in the rate of inflation are usually caused due to the two key factors present “Supply and demand”. The higher rise in inflation creates a downstream for the stock prices that get affected largely. According to the recently published article Forbes.com (2023), the negative trend of the stock market is largely affected by the growing interest rates than the actual inflation pressure created in the UK. The value from the investment is not confirmed and they can impact the original amount invested by the investor.

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Problem statement

The stock market in the country UK has been facing several problems due to the change in the interest rate, which is the effect of the inflation rate. However, this growth rate of inflation is also creating problems for investors. Accordingly, the rising inflation rate not just only falls an effect on the stock market, but also affects the economy of the country UK. The research will be made to understand these problems and to analyze the effect of the inflation rate on the stock market and the country's economy. During increasing inflation, the profitability and growth margins of corporations might get a hard hit. This affects the investor's point of view and stimulates their willingness to hold stocks and shakes their confidence.

Significance of the study

Inflation has gradually created an adverse impact on most of the prices of assets, making it difficult for investors to make their decisions in investment. This research will be useful; to understand the effect of the inflation rate on the stock market and price. Accordingly, the study will be helpful to provide an idea about the rising inflation rate effect on the UK market.

Background

The context of stock returns and inflation covers an accumulative perspective of the macroeconomics and finance areas. The determination of the inflationary pressure and the stock returns quantifies the extent to which the stocks can be hedged against inflation risk and is of utmost importance for the financial economist. The stock market is primarily an area of direct sources of financing for firms. On the contrary, the alterations in the stock market returns affect financial stability, and real economic activity, including borrowing and investment decisions.

Context

It affects household consumption and savings decisions that are highly induced by changes in net worth. Historically, real stock prices decrease with the rise in inflation, especially in developed economies like UK (Forbes.com, 2023). Whereas, when inflation increases in a country the central banks usually increase the rate of interest in order to bring a certain limitation and erode the liquidity in the markets. Therefore as a result of which the overall stock prices reduce.

Figure 1: Inflation rate in the UK from 1987-2027

(Source: Statista.com, 2023)

Aim of the research

The aim of the research study is to identify the impact of the inflation of stock prices in the UK economy.

Objectives

• To identify the impact of inflation on the market performance
• To identify the impact of inflation on the stock prices
• To evaluate the relationship between the increase in inflation and stock performances in the UK market

Research questions

Q 1. What is the impact of inflation on market performance?

Q2: What is the impact of inflation on stock prices?

Q3: How do the increasing inflations affect the stock market performance in the economy of the UK?

Literature review

To identify the impact of inflation on the market performance

Based on the research work of Huy et al. (2020), during the period of inflation, the profit margins and revenue of the companies get lower affecting the entire decision and eagerness of the investors to further hold the stocks. In order to compensate for the rising inflationary burden and decreasing purchasing power governments tend to increase the rates of interest on deposits and loans. The motive behind the action is to curb the excess liquidity and therefore stimulate the excessively increasing demand downwards.

Figure 2: Factors that tend to increase inflation

(Source: Antono et al. 2019)

It is a probable course of action that can probably bring changes in the inflation scenarios. Similarly, the increase in the rate of interest creates a shift of assets towards the debt from the equity side, as a result of which the risk-reward ratio fluctuates (Antono et al. 2019). One of the probable causes is why investors keep shifting from equity toward debt.

To identify the impact of inflation on stock prices

Inflation tends to affect the equity market and affect consumer spending power. The increasing costs and the uncertainty in the growth of revenues can significantly take a toll on the “corporate profit margins”. In the opinion of Alqaralleh (2020), inflation and necessarily not bad for the stock market performance, rather the growing interest is found to be the reason that affects the stock market performance. The rising prices of goods and commodities tend to create huge pressure on the demand and supply perspective of the market. Additionally, it injects a higher level of uncertainty into the market. As per the views of Celebi & Hönig, (2019), it can evidently be seen that the increasing inflationary burden can create negative pressure on bonds and equities. It will additionally bring slower economic growth and decrease profitability for the majority of the firms.

Figure 3: Impact of the inflation on the share market

(Source: economicshelp.org, 2023)

To evaluate the relationship between the increase in inflation and stock performances in the UK market

The impact of the inflationary pressure has created a significant fall in the stock market returns of the UK economy. Based on the views of Huy et al. (2020), empirical research conducted states there has been a major hedge in the stock market performance of the UK- economy against the increasing inflationary boundaries. However, the results that have been collected from different sources suggest that the performances in the various regions are different from each other. The empirical evidence depicts that the increase in the rate of inflation is caused to the accumulative changes in the average consumer price index. In addition to that, the major backlashes of economic activity reduce the stock prices of the economic market (Celebi & Hönig, 2019). While examining the stock market performances of the S&P 500, it has been seen that there has been a significant reduction in the returns within the highest real returns happening during the inflation is 2% to 3%. The cost of living in the UK economy has certainly increased during the period 2021 and 2022. The rate of inflation annually reached 11.1% in October 2022 (Forbes.com, 2023). This has additional affected the consumer’s cost of living and the making the stock market performance more volatile.

Proposed methodology

Research Philosophy

Research philosophy is the effective process that helps in gathering utilizing, and gathering the proper data and information. It deals with the accurate source of ideas and knowledge that will appear to be imperative in nature while completing the research study (Pandey & Pandey, 2021). The research will make use of the positivism philosophy that will focus on collecting information based on factual and real-life data. It will be useful for the researcher to investigate and interpret the collected data. Additionally, the research will be using statistical methods to complete the research study with a high level of adequacy.

Research method

The research study is highly dependent on the quantifiable data and information that will allow the drawing of solid conclusions about the research background. The secondary quantitative data will be used by the researcher for completing the research study. However, the analysis of correlation will be helpful to discuss the relationship between inflation and the change in the stock market. Accordingly, the regression calculation will be necessary to demonstrate the effect of these two variables on each other. Hence, secondary quantitative research method will be used which will focus on gathering data from various companies’ stock market data who are under the UK stock market.

Data collection

The research will be using secondary qualitative data sources for the completion of the research topic. The interpretation of the quantitative data analysis will be done based on the research objectives. The researcher will complete the research study using the information available on online websites, scholarly articles, journals, and authentic annual reports of the companies. The data will also be collected from the stock market information in order to understand impact of inflation in the stock performance of the companies. The information provided on the authentic governmental sites will be further investigated to fet6ch useful information and historical data.

Ethics and consideration

The researcher will properly abide by the ethical and legal considerations needed to follow while collecting information and data for the background. The ethical code of conduct will be necessarily followed in order to maintain the secrecy and privacy concerns of the research topic. Additionally, the researcher will ensure that no piracy or outsourcing of data is done for commercial purposes. The anonymity of the workers will also be maintained during the entire research study while conducting the survey. Meanwhile, the researcher will also abide by the “Data Protection Act 1998” while investing information for the proposed research study (Newman & Gough, 2020).

Hypothesis

H0: There is a positive relationship between inflation and stock market performance in the UK

H1: There is a negative relationship between inflation and stock market performance in the UK

H2: There is no relationship between inflation and stock market performance in the UK

Limitations

The limitation that the researcher can face while collecting information related to the research topic and the main theme for the research background is time constraints. Additionally, the availability of adequate resources and information for the research topics is also concerned to be one of the vital limitations that the researcher can face. The unavailability of accurate theories, due to a lack of sources provides a major gap for the researcher to complete the research study. In addition to that, the lack of adequate permission in particular regions due to the Covid-19 implications might create problems for the researcher to complete the research will a high level of adequacy.

Brief summary

The entire summary can be drawn based on the proposed methods that the researcher will be using for the study. Research philosophies that the researcher will use for the completion of the research study with high authenticity. Additionally, the data collection methods that will be used have been discussed making an imperative impact on the way the researcher will gather the data. The methodology section describes the various ways and processes in which the researcher will be collecting vital information related to the background of the topic. The entire discussion for the needed methodology for the topic has been described that the researcher is going to use in the future.

References

Alqaralleh, H. (2020). Stock return-inflation nexus; revisited evidence based on nonlinear ARDL. Journal of Applied Economics, 23(1), 66-74. Retrieved on 4^th March from: https://www.tandfonline.com/doi/pdf/10.1080/15140326.2019.1706828

Antono, Z., Jaharadak, A., & Khatibi, A. (2019). Analysis of factors affecting stock prices in mining sector: Evidence from Indonesia Stock Exchange. Management Science Letters, 9(10), 1701-1710. Retrieved on 4^th March from: doi: 10.5267/j.msl.2019.5.018

Celebi, K., & Hönig, M. (2019). The impact of macroeconomic factors on the German stock market: Evidence for the crisis, pre-and post-crisis periods. International Journal of Financial Studies, 7(2), 18. Retrieved on 4^th March from: https://www.mdpi.com/2227-7072/7/2/18/pdf

economicshelp.org (2023) How inflation affects the stock market Retrieved on 4^th March from: https://www.economicshelp.org/blog/167981/economics/how-inflation-affects-the-stock-market/ Retrieved on 4^th March from:

Forbes.com (2023) How Does Inflation Affect Stocks Retrieved on 4^th March from: https://www.forbes.com/advisor/investing/inflation-and-stock-market/#:~:text=An%20inflation%20rate%20between%201,leading%20to%20lower%20economic%20growth.

Huy, D. T. N., Dat, P. M., & Anh, P. T. (2020). BUILDING AN ECONOMETRIC MODEL OF SELECTED FACTORS’IMPACT ON STOCK PRICE: A CASE STUDY. Journal of Security & Sustainability Issues, 9. Retrieved on 4^th March from: http://doi.org/10.9770/jssi.2020.9.M(7)

Newman, M., & Gough, D. (2020). Systematic reviews in educational research: Methodology, perspectives and application. Systematic reviews in educational research: Methodology, perspectives and application, 3-22. Retrieved on 4^th March from: https://doi.org/10.1007/978-3-658-27602-7_1

Pandey, P., & Pandey, M. M. (2021). Research methodology tools and techniques. Bridge Center. Retrieved on 4^th March from: http://dspace.vnbrims.org:13000/jspui/bitstream/123456789/4666/1/RESEARCH%20METHODOLOGY%20TOOLS%20AND%20TECHNIQUES.pdf

Statista.com (2023) United Kingdom (UK): Inflation rate from 1987 to 2027 Retrieved on 4^th March from: https://www.statista.com/statistics/270384/inflation-rate-in-the-united-kingdom/