Exchange Rates – Understanding The Effects That Stem From Fluctuation.

We generally take exchange rates as a fairly stable component of our daily lives whereby the price of daily indulgences stays consistent.. It’s common for us only to take an interest in exchange rates when we’re planning a trip abroad and need  to exchange money.

However, the indirect impact of exchange rates and their fluctuations extend much deeper than just your holiday money, to the point that it can affect the most important aspects of our lives. Exchange rates are known for having an enormous influence on the economy in the short and long term.

Goods

It’s commonplace in most countries to have a plethora of global products whereby purchasing outweighs a domestically produced product. We should be aware that with these international products, that exchange rates can have a direct impact on the cost. This would be highlighted when during a weak exchange between two specific currencies would result in a product costing more than previously. However, the fluctuations are difficult to predict, as exchange rates between currencies have a dependency on it’s performance with other currencies.

Job prospects

Unfortunately, economic growth when there’s a weak exchange rate is boosted by exports, whereas on the contrary, it would mean that imports are more expensive. When there is quicker economic growth, this usually correlates to better employment prospects.

As for a strong domestic currency, it will have a different and opposite effect, being that there is slow economic growth and it will hinder employment prospects.

Increased property prices

When the exchange rate start generating lower interest rates, it becomes cheaper to borrow money. This results in an increased encouragement to spend more money and invest around the property market, leading to a higher demand and economic growth.

Lower interest rates mean:

  • Cheaper borrowing costs: As previously mentioned, when there are lower interest rates, it causes the cost of borrowing money to become cheaper. Thus encouraging all consumers to take out loans.
  • Rising asset prices: When the interest rates are low, it becomes a more attractive idea for consumers to invest money on property. This causes property prices to increase thus leading into a rise in wealth.
  • Lower the mortgage interest payments: When there is a fall in the interest rates it causes the monthly costs of any mortgage repayments to go down as well. Leaving householders with more usable money and encouraging them to spend it.

The problem occurs when the people who want to take advantage of the lower properties prices are to have the sufficient money to be capable of purchasing. Unfortunately, this market encourages international interest for cheaper investments who are not experiencing a downturn in finances. It then renders purchasing properties extremely difficult even though the economy will receive a boost from international investment.

Impacting inflation – changing interest rates on savings & loans.

A consequence of the value of international trade for countries, many largely importing countries can struggle with the fluctuations of exchange rates. These countries can experience a weak domestic currency that leads to an increase in inflation resulting in the central bank having to increase interest rates to counter inflation.

These higher interest rates can have a significant effect on the amount of money being spent within an economy following people being unable to borrow and afford repayments. Coincidently this significantly pushed the amount of PPI being undertaken to ensure that there was an additional safeguard to make repayments.

The reasoning behind the central banks movements is to reduce the amount of money borrowed which will not be repaid and results in a loss to the bank. As a consequence, the reduction in disposable income being spent causes the economy to slow down and also inflation.

Alternatively, if inflation has significantly dropped, then the economy would be boosted, resulting in a decrease in interest rates to encourage people to borrow and spend their money to continue  growing economy.

Portfolio returns

Fluctuations in exchange rates will have a large impact on investment portfolios, including domestic investments. Domestic investments will generally feel a down-turn in international trade and also a saturation of spending means a reduction in earnings and value. However, part of the negative impact would be nulled by the weaker local currency.

Luckily, the effect that exchange rates have on portfolio returns are very well documented and published when investing. Nevertheless, investments in securities which are denominating in a depreciating currency will return the final return of investments whereas investments in an appreciating currency will see a boost in it’s return.

All wrapped up

When it comes to indirect effects of the currency fluctuations, minimising the direct effect caused due to the greater influence exerted on the economy in both the long and short term.

Indirect effects of the exchange rates will extend to the prices being paid at the supermarkets, loans, savings and their interest rates as well as job prospects, investment portfolios and the prices on housing around your area.