How Prolonged Inflation Can Affect Foreign Exchange Rate

Inflation is not just one factor which causes volatility in foreign exchange rate, yet it is considered to be one of the major influencing factors. This is mainly because, inflation hits hard on the value of a currency through its negative effect. A particular currency of any country becomes weaker compared to the other currencies as its purchasing demand lowers down.

Inflation- Meaning

Common explanation of the term inflation refers to a persistent rise in prices over time. It indicates a free market principle of supply and demand. When the demand for a product is greater than the supply (in a free and open market) in such situations, the prices of that product tends to increase. Inversely, when supply is greater than demand in such a situation we find prices go down. Simply put, with too much of product supply in the market each unit loses value.

Technically speaking, inflation is not so much about an increase in prices, but the decrease in the buying power of the dollar. Investors who deal with international goods or services are hugely affected by forex rates. The higher inflation rates can cause exchange rate depreciation, potentially leading to higher import prices.

It even leads to higher inflation and more depreciation in the foreign exchange rate. This is relatively a rare situation and should not be often observed, provided that periods with high inflation are usually met with an increase in domestic interest rates.

This article was first published by Myforexeye

Source: https://bit.ly/2OqrMIs