How Does Inflation Affect Exchange Rates?

Exchange rates play a vital part in indicating the overall economic health of a country. It is also an essential aspect of international trade that countries depend on to progress. It is also one of the most important factors of international exchanges especially the forex market. That’s why it’s no wonder that traders, market participants, governments, and basically anyone in the finance industry watches the exchange rates closely.

To illustrate the role of exchange rate let us first examine how it affects international trade as this is what serves as our ties towards other countries. Basically, in international trading, there are two actions: importing or buying goods from other countries, and exporting or selling goods to other countries. Countries buy and sell the goods on their respective currencies. Then there’s exchange rates. It is the comparison between two currencies. The value of the currency will then determine how much a currency can buy or sell versus another country’s currencies.

Thus, exchange rates carry a huge significance in an economy’s health.

Inflation

As mentioned earlier, along with exchange rates, the other indicator of economic health are inflation and interest rates among others. These three are constantly interacting and influencing each other. That’s why differentials in inflation and interest rates affect exchange rate.

Inflation is the overall hike the prices of goods while the purchasing power declines.

Lower inflation in a country means a higher currency value therefore an increased purchasing value versus other currencies. Higher inflation means vice-versa. The exchange rates is influenced by the rise and fall of inflation.