highlights the relationship between inflation and currency direction to understanding inflation and how it affects foreign exchange trading. The rate of inflation in a country can have a major impact on the value of the country's currency and the rates of foreign exchange it has with the. As Canada's inflation rate fell, so did the value of its currency – at least when compared to the US dollar. While the loonie depreciated greatly.
How inflation affects the exchange rate A higher inflation rate in the UK compared to other countries will tend to reduce the value of pound because: Therefore UK goods become less competitive. Demand for UK exports will fall, and therefore there will be less demand for Pound Sterling. Also, UK consumers will find it more attractive to buy European imports. Therefore they will supply pounds to be able to buy Euros and the Euro imports. This increase in the supply of pounds decreases the value of Pound Sterling.
Therefore, in the long run, changes in relative inflation rates should lead to a change in the exchange rates. In the post-war period, the UK experience a higher inflation rate than Germany.
This caused the Pound Sterling to depreciate against the German Mark. It was a reflection that German industry was becoming more competitive than UK industry. Also, markets anticipate future inflation.
Understanding Inflation for Currency Trading
If they see a policy likely to cause inflation e. How the exchange rate affects inflation If there is a depreciation in the exchange rate, it is likely to cause inflation to increase.
Import prices cheaper Why a depreciation causes inflation A depreciation means the currency buys less foreign exchange, therefore, imports are more expensive and exports are cheaper.
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Inflation and Exchange Rates
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Or, read more articles on DailyFX You are subscribed to Benjamin Spier You can manage your subscriptions by following the link in the footer of each email you will receive An error occurred submitting your form. Please try again later. Back Inflation is one of the most important gauges for a currency trader to track, yet one of the more confusing pieces of data. A high inflation rate might normally be a bullish sign for one currency, but at the same time it could also be currency negative.
Therefore, we layout a guide to understanding inflation and how it affects foreign exchange trading. Inflation reports monitor the rise of the prices of basic goods and services in an economy, inversely the rate at which purchase power is falling.
Think of it as a measure of how much you can buy with a dollar; e.