Exchange Rate – Currency appreciation and depreciation

n this blog Global Market Astro has tried to explain its blog readers regarding currency appreciation and depreciation in simple terms.

Currency Appreciation

Currency Appreciation may be defined as an increase in the value of one currency with respect to another currency. Appreciation of one currency against another currency may be due to various reasons, including the country’s current account and capital inflows. Usually a forex trader trades a currency pair with the hope of base currency’s appreciation against the counter currency.

Currency traders have to take into account currency appreciation when making a trade, since a long-term currency option contract might see its value decline if the value of the underlying currency adjusts. Moreover, when a currency appreciates it becomes more expensive to buy that country’s exports. This can cause a narrowing in the economy, which can have added impact in the value of the currency.

Currency Depreciation

Currency Depreciation may be defined as a decrease in the level of a currency in a floating exchange rate system due to market forces. Currency depreciation can occur due to many numbers of reasons such as economic fundamentals, interest rate differentials, political instability, and risk aversion among investors and so on.

Countries with weak economic fundamentals such as prolonged current account deficits and high rates of inflation normally have depreciating currencies. Currency depreciation, if orderly and measured, improves a country’s export competitiveness and may improve its trade deficit over time. But sudden and large currency depreciation may panic foreign investors who fear the currency may fall further, and lead to them withdrawing their portfolio investments out of the country, putting added downward pressure on the currency.

Easy monetary policy and high inflation are two of the main reasons of currency depreciation. In a low interest-rate environment, hundreds of billions of dollars chase the highest yield. Expected interest rate differentials can initiate a bout of currency depreciation.Currency depreciation can also be caused due to inflation. This is because the higher input costs for export products made in a high-inflation country will make its exports noncompetitive in global markets, which will increase the trade deficit and cause the currency to depreciate.

Source:https://www.globalmarketastro.com/blog/exchange-rate-currency-appreciation-and-depreciation/