How Will Gold Prices be Affected by 2% Inflation?

With rampant inflation over the past couple of years, the Federal Reserve quickly raised interest rates and has held them steady for the past year. Meanwhile, gold prices have been strong recently, with the price of gold per ounce hitting a record of over $2,400 in May. Although gold prices have come down slightly since then, they’re still up over 20% in the past year. Meanwhile, inflation has been showing signs of moderating recently too, although it could still be a while until it reaches the Fed’s 2% target.

If that happens, what could it mean for the price of gold? In some ways, high inflation could help the price of gold, as the precious metal is often purchased to try to hedge against inflation. 

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What will happen to the price of gold if inflation hits 2%?

Inflation is only one of multiple factors that can (and have) shaped the price of gold. So, even if it falls, gold could still rise in value for other reasons.

At the same time, high interest rates that are used to try to tame inflation can temper the price of gold, as high interest rates give investors an attractive option for essentially risk-free returns, like by buying Treasuries or even keeping money in a high-yield savings account.

So, some think that gold prices could fall as inflation drops to 2%.

“If and when that occurs, that could potentially deter some demand in gold and might lower the price,” says Alex Ebkarian, COO and co-founder of Allegiance Gold, a gold investing company. 

“However, it’s a mistake to just look at the Fed’s reported inflation because it only measures year over year. Looking at the last three-year cumulative compound impact of inflation continues to be evident at the grocery stores and reflective on the price increase of gold,” he adds. 

So, in that sense, with gold often being seen as a store of value, gold prices could potentially remain strong even if inflation hits 2%, at least in the beginning of that low inflation period.

Learn more about investing in gold during today’s inflationary cycle now.

Other considerations

Although there’s a case to be made in both directions in terms of how lower inflation could affect the price of gold, many experts see other factors being bigger drivers.

“The price of gold does not follow the inflation rate closely over the short to medium term. Thus, even if the Fed brings inflation down to 2%, there is no way of determining the behavior of the price of gold,” says Roger D. Silk, Ph.D., founder and CEO at Sterling Foundation Management, a wealth management company.

Instead, the price of gold might be influenced by broader economic and geopolitical factors, beyond just inflation.

Some investors, for example, turn to gold as a counter to the dollar, which could potentially weaken due to large government deficits that have been running since fiscal year 2002 across presidential administrations from both parties.

“Considering the current debt level and overall cost of interest expense and on-going de-dollarization movement, and the volatility nature of the market, coupled with some early signs of weaknesses in banks lead by the commercial real estate sector, I expect the reported taming of inflation would have a neutral impact on gold,” says Ebkarian.

Meanwhile, “other forces such as gold’s no-default risk, historical positioning, liquid nature and performance during times of crisis attributes are attracting new strategic investors that are more interested in ownership rather than exposure,” he adds.

The bottom line

At first glance, inflation might seem to move the price of gold, but many other factors are also involved. Thus, if and when the US reaches the Fed’s 2% target, that does not necessarily mean that gold prices will move up or down, as other factors such as government deficits and political instability around the world could influence gold investors who are looking to diversify.