What Causes An Appreciation In The Exchange Rate
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An appreciation in the Exchange rate can occur for various reasons. The most
significant reasons include higher interest rates and lower inflation. An
appreciation of the exchange rate can have a significant impact on a country's
economic growth and inflation therefore it is important to understand what can
cause an appreciation in the exchange rate.
1. Higher interest rates. If interest rates rise then it makes it more
attractive to save money in UK banks and UK financial securities like bonds.
Therefore this causes increased demand for sterling to deposit money in the UK.
This is called “hot money flows” The higher demand for sterling causes an
appreciation of the exchange rate. It is a significant factor because of the
high volume of foreign exchange which is transferred between countries to take
advantage of differences in interest rates.
2. Inflation Rates. If inflation in the UK is lower than elsewhere
then it makes UK goods relatively more attractive. Therefore there is an
increase in demand for UK exports and therefore higher demand for sterling this
will cause an appreciation. This is a significant factor in the long term.
3. Speculation. A lot of exchange rate movements are due to
speculation. If people think an exchange rate may increase in the future then
they will buy now to try and make profit. Therefore this speculative buying
causes significant fluctuations in the exchange rate. The attitude of foreign
currency dealers to an economy is very important for determining the exchange
4. Increase in competitiveness. This is related to lower inflation. If
a country becomes more competitive because of increased labour productivity then
there will be more demand for UK goods and the exchange rate.
5. Current Account Surplus. This means the value of imports (of goods
and services) is less than the value of exports. Therefore more foreign currency
is coming into the country than going out. (although it may be offset by a
surplus on financial / capital account.
About the Author
Richard Pettinger studied Politics and Economics at Lady Margaret Hall,
Oxford University. He now works as an economics teacher in Oxford. He enjoys
writing essays on Economic and he edits an Economics Blog focused on UK and US
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Article Published/Sorted/Amended on Scopulus 2007-03-16 23:58:42 in Economic Articles