Currency fluctuations can occur if a country's currency is subject to a floating exchange rate system. So, the exchange rates get determined by the market forces, like inflation, interest rates, and capital flows. These could affect the vital aspects of the economy.
Many people tend to think of the constantly fluctuating currency values when making online purchases or planning a trip abroad. However, the impacts of the ever-fluctuating exchange rates also touch the other aspects of our lives indirectly.
In this guide, we look at how currency fluctuations can affect our economy, both direct and indirect impacts. Keep reading to learn the effects of exchange rates.
Impacts of Fluctuating Exchange Rates on the Economy
While changes in a currency’s exchange rates might seem not to affect many people’s lives, the indirect impacts are more widespread. The exchange rates can affect the:
- Job market
- Real estate sector
- Investment performance
- Inflation and interest rates
- Prices of goods and services
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The Job Market
If the domestic currency is weaker against a foreign currency, it will stimulate economic growth. The number of exports will increase while imports become more expensive. As a result, many consumers will have to rely on domestic goods and not imported ones.
How does the increasing reliance on domestic products affect the job market? As many people buy domestic goods, the economy grows faster, creating more employment opportunities. Other countries with stronger currencies will hire workers from here.
If a country’s domestic currency grows stronger, it can export fewer goods. Companies that do not export will now have to compete with cheaper imports. Some of them may even outsource workers from overseas, resulting in fewer jobs for the natives.
For example, if the US Dollars grows stronger than the Canadian Dollar, most American companies will hire Canadians to get cheap labour. So, the number of job prospects for Americans in the US will reduce. Check the USD-CAD currency exchange in Windsor.
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The Real Estate Sector
If you plan to invest in a foreign country’s real estate market, you will have to watch the currency exchange rates. The fluctuating rates can affect foreign real estate values, real estate investors, and real estate prices. Here are the impacts of the three factors?
- Foreign Investors: If a foreign currency grows stronger, there will be an influx of foreign investors in the local real estate market. They will have a high purchasing power, making the local property investments more appealing to them.
- Real Estate Values: Your home currency’s strength will determine a property’s value when carrying out a foreign country's real estate transaction. If the home currency is stronger, use it to buy a property in a foreign real estate market.
- Real Estate Prices: Currency exchange rates can also affect rental income and real estate prices. If a foreign currency is stronger than the CAD, you’ll use more dollars to buy a foreign rental property. That will increase the rental prices.
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Investment Performance
Fluctuations in currency exchange rates can also affect your investment portfolios, even if you’ve not invested in the foreign markets. A stronger currency can either hurt or help stocks. Many investors will invest in the stock market with a stronger currency.
On the other hand, a strong currency will make the country’s stocks more expensive for many foreign investors. A weak currency can be helpful if you already hold foreign stocks. The values in your investment portfolio will seem higher in your local currency.
A strong currency can also affect the sales and profits you’ll earn overseas. If you invest in securities denominated in an appreciating currency, the returns on your investment portfolio will increase. But if the currency is depreciating, your total returns will reduce.
For example, European stocks recorded the highest indices in the first four months of 2015 when the US Dollar was progressing quite aggressively. American investors who invested in the shares would have seen their returns reduced by the depreciating euro.
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Inflation and Interest Rates
If a country imports many goods, its inflation rate will rise substantially if the currency weakens. Importers will be buying foreign products at a higher price than usual. As a result, the central bank may increase the interest rates to counter rising inflation.
Conversely, a country with a strengthening currency tends to record low inflation rates. It will be importing goods from other countries at lower prices, reducing the inflation rate further. In response, the central bank will reduce or keep interest rates low.
Many central banks always consider exchange rates when setting monetary policies. In 2012, the then Bank of Canada's governor, Mark Carney, said that the bank took into account the Canadian Dollar’s persistent strength when setting its monetary policy.
Tighter monetary policies mean higher interest rates. So, a strong domestic currency will boost the economy and result in tighter monetary policies. Tightening a monetary policy further when the domestic currency is strong may worsen the situation.
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Prices of Goods and Services
The constantly fluctuating exchange rates can have a significant impact on the prices of goods imported or exported. If the domestic currency is weaker, you’ll pay more money when importing goods from a country with a stronger currency.
On the other hand, if the domestic currency grows stronger relative to a foreign country, the prices of goods imported will drop accordingly. However, it will negatively affect the profits made by the exporting nation. Let’s look at an example to illustrate more.
If the USD/CAD exchange rate moves from 1.15 to 1.25 within one year, it will mean the CAD has weakened against the USD. So, what will be the price change in Canada for a pound of Almonds available in the United States for US$8?
Assuming other costs, the price of one pound of almond will cost CA$9.2 (US$8 x 1.15) before the change in exchange rates. After the fluctuation of the exchange rate, the new price of one almond will increase to CA$10 (US$8 x 1.25).
Final Words
A change in a currency’s strength can affect the economy directly or indirectly. When the exchange rates increase or decrease, the indirect impacts will be more widespread than the direct ones. The indirect effects extend to the prices of goods in a supermarket, returns on investments, interest rates on loans and savings, and job prospects.
