Currency appreciation in the same context is an increase in the value of the currency. Short-term changes in the value of a currency are reflected in changes in the exchange rate.
Basics of Currency Appreciation
In a floating rate exchange system, the value of a currency constantly changes based on supply and demand. Therefore, the fluctuation in values allows traders and firms to increase or decrease their holdings and profit off them.
Currencies are in pairs. Thus, a currency appreciates when the value of one goes up in comparison to the other. This is unlike a stock whose appreciation in price is based on the market’s assessment of its intrinsic value. Typically, a forex trader trades a pair in the hopes of currency appreciation of the base currency against the counter one.
Appreciation is directly linked to demand. If the value appreciates (or goes up), demand for the currency also rises.
How, exactly, do we define this term?
Firstly, the rate directly corresponds to the base currency. For example, If the rate increases to 110, then one U.S. dollar now buys 110 units of Japanese yen. If the currency depreciates that means one U.S. dollar can only buy Japanese yen in the value of less than 100. Therefore, depreciation and appreciation can have a part in contributing to exports and imports.
Causes of currency appreciation
- Increase in the policy interest rate by the central bank: if the central bank increases the policy interest rate, it would make the investors attractive to invest in the government bonds and domestic securities which can lead to an inflow of foreign investment in the form of hot money. This can lead to the appreciation of the domestic currency.
- Current account surplus: current account surplus can cause an inflow of foreign exchange in the economy leading to appreciation in the exchange rate of the domestic currency.
- Increase in exports: increase in exports can increase the demand for the domestic currency leading to its recognition concerning foreign currencies.
- Intervention by the central bank through open market operations: buying domestic currency from the foreign exchange market by the central bank can lead to an appreciation of the domestic currency.
- Higher economic growth can increase foreign investment in the economy which can cause appreciation in the exchange rate.