What Creates Currency Appreciation?

What is currency appreciation?

It is the increase in value of a currency at the expense of another one. Currencies are traded in currency pairs, where one currency is priced against another one. If one currency is seen as more attractive then it increases in value, whilst its 'partner' loses value. Increased liquidity makes a currency attractive to trade due to its availability. An example of a currency pair which is highly liquid is the EURGBP.

Political events:

There are numerous reasons why a currency depreciates or appreciates. Recently Pound undervalued was a theme which was created by political weakness. As the UK did not have a strong government, GBP was seen as unattractive. Other currencies such as the EUR and USD appreciated against it.

Seeking uncle Sam's protection...

A currency can appreciate because of the confidence that investors have in it. A flight to quality in a period of uncertainty is such an example. The USD is seen as a trustworthy currency, which in times of stress appreciates as investors sell other currencies which are seen as riskier. The Greenback's strength is derived from a stable political system, a strong economy and an independent judiciary, all of which are required to give confidence to investors.

Why interest rates are sexy!

Interest rate rises are a boon to a currency increasing in value. This is due to the twin attractiveness of yield and the popularity this creates with other investors. If a currency pays a higher interest rate (or any yield in the current climate!) then investors flock to it. As more investors buy this currency it increases in value, an excellent example of currency appreciation!

Academic currency appreciation

Another key influencer of currency appreciation is economics. If an economy is predicated to grow, then its currency will become attractive. Economic growth leads to the creation of money. Investors are looking to make money, and an economy which is expanding will be an attractive place to deploy capital. As investors sell their assets in other currencies to invest in a growing economy, the demand created increases the value of this domestic currency.

Conclusion

In the short run every currency can appreciate over a few seconds or minutes due to volatility. Over the long run foreign currency can appreciate due to slower developing factors. Economic factors such as trade balances can have a strong influence on the floating exchange rates of countries. It is also worth remembering that things change, Who would of thought that central banks would become the de facto Chief Investment Officers of markets with their use of quantative easing? Despite all this, some things remain constant. The strength of the United States is their ability to produce wealth. In good times and bad the US dollar is a good bet for currency appreciation!