Inflation and currency exchange

Inflation and currency exchange

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A country’s inflation rate is one of the factors that can significantly influence its currency value as well as its foreign exchange rates with other nations

If you make international payments for personal or business reasons, you may find it helpful to monitor inflation and currency exchange rates with the help of a specialist provider such as moneycorp.

How does inflation affect foreign exchange rates?

A good general rule is that if inflation affects the foreign exchange rate, the effect is usually negative rather than positive. An inflation rate that is very high is extremely likely to negatively impact the country’s exchange rates with other countries. Furthermore, inflation is linked to interest rates, which is another factor that can influence exchange rates.

What is inflation?

Inflation refers to a general increase in prices, and it is gauged by the consumer price index.

To calculate the monthly or yearly rate of inflation in a country, you would need to calculate the percentage change in the index between two periods in time. Inflation is caused by a faster increase in the level of money supply relative to wealth production, which is gauged by the GDP. In short, there’s an increase in demand for a supply that increases at a slower pace.

Inflation, interest rates, and currency exchange

The connection between interest rates, inflation, and currency exchange rates means you should monitor all three for a more complete picture. The relationship between them is complex, making it difficult for countries to balance inflation and interest rates.

Low interest rates generally have a positive effect on the value of a country’s currency. This is due to their encouragement of economic growth and consumer spending. However, if that spending leads to a situation where demand outstrips supply, this may lead to inflation. Low interest rates are not usually known for attracting international investment.

Although higher interest rates can discourage consumer spending, they usually attract foreign investors. That, in turn, should lead to an increase in demand for the country’s currency. You could almost say that inflation affects the foreign exchange rate in a roundabout way.

It is important to remember that attracting foreign investments is one thing; retaining them is another. If a country is seen as being economically or politically unstable, or there is a chance its currency could devalue suddenly, investors aren’t likely to hold the currency in large amounts or for long periods of time.

Other factors that can affect the value and exchange rate of a country’s currency include:

  • Interest rates
  • The balance of trade
  • Economic growth
  • The country’s debt level
  • The currency’s perceived desirability

How will the anticipated inflationary increases affect the exchange rates of different countries?

The anticipated inflationary increases are only one of the economic indicators that investors monitor when determining exchange rates. This is because no single influence predominates continually. Economic growth may influence the rates until another factor, such as inflation or interest rates, comes to exert a greater influence on the demand for a currency.

Whether you consider interest rates or inflation and currency exchange rates, you find that exchange rates are relative. A currency’s value comes down to its domestic purchasing power and its perceived value in relation to other countries’ currencies.

For this reason, factors that can affect a country’s exchange rate, such as inflation, can themselves be influenced or their effects mitigated. For example, country A can have a rate of inflation that economists regard as high, but if that rate is lower than country B’s rate, country A’s currency can be relatively higher than that of B’s.

Our currency exchange and inflation chart

Monitoring inflation and currency exchange rates can help you make the best decisions for your business and personal international payments. Our currency chart enables you to track the exchange rates of various currencies and keep up to date on the information you need surrounding the foreign exchange market.

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