What factors cause a currency to appreciate?
There are several factors which can cause a currency to appreciate. Two of the most important are:
Inflation and interest rates
Where low inflation rates persist, central banks tend to cut interest rates to try and stimulate spending in the economy. A lower interest rates means holding the currency becomes less attractive relative to currencies that pay a higher interest rate. This typically results in less demand for the currency and often causes the currency to depreciate, however it is not always so finely out.
Investor sentiment
Currencies can also appreciate depending on how ‘safe’ investors view the country’s central bank and government.
For example, Switzerland has long been considered a safe haven for investors, which means the currency appreciates in times of economic crisis. This is because of its historic neutrality in wars and tendency towards political stability and relatively free monetary policy; as well as its openness to foreign investment. These policies have made the Swiss franc one of the most heavily-traded currencies in the world.
Investor sentiment heavily influences the supply and demand for a currency on the open market, which are perhaps the largest drivers behind whether a currency appreciates or depreciates. The currencies which are most susceptible to influence by supply and demand are those that operate on a floating exchange rate.
