An investigation of the relationship between the inflation rate and equity price movements at the Nairobi Stock Exchange

Abstract

The study was carried out to examine if there is a relationship between NSE stock prices and inflation for the period covering 1999 to 2010. The hypothesis tested aimed at showing the relationship between the NSE 20 share index and CPI, inflation and expected inflation. Secondary data was used in the study and was obtained from different sources including Kenya National Bureaue of Statistics, Central Bank of Kenya, Nairobi Stock Exchange and various publications of the University of Nairobi. The data was regressed using The Error Correction Mechanism, due to non-stationarity. Results obtained showed that there is indeed a significant relationship between NSE 20 share index and CPI and Nse 20 share index and expected inflation. The Inflation variable used indicated the existence of a relationship but was insignificant. Based on these results, the study recommends investor education, as there is need to understand the relationship between the stock market and both the CPI movement, the expected inflation and the entire economy. The government needs to ensure that both the monetary and the fiscal policies are carefully applied as they significantly affect both the CPI and the inflation expectations. The NSE should also introduce other alternative investment channels such as options, futures, REITS and commodity trading so that it can be able to compete globally and also offer alternative investment channels for investors not willing to invest in the stocks entirely.