What are the Major Causes of Currency Appreciation in Canada?

One of the major causes of a shift in a country’s economy is currency appreciation. It happens when a country’s currency increases in value compared to another state’s currency, which can be seen in the nominal exchange rates.   

Some significant factors causing currency appreciation are the forces of demand and supply, inflation rates, interest rates, and debt repayments. In addition, government intervention to influence the value of the country’s currency and economic growth can also cause appreciation. 

Currency appreciation affects a country’s economy in positive and negative ways. For example, an increase in currency value leads to a decrease in import prices, which is advantageous to traders. However, the appreciation also causes an increase in export expenses, reducing the gains from exports in the country. 

What Causes Currency Appreciation?

Currency appreciation can be due to one significant economic change or a combination of factors. Some of the reasons for appreciation in currency are;

• Inflation

Inflation is one of the leading causes of the increase in currency value. It is the rate at which prices of commodities and services rise over time. When the price of items increases, the value of the dollar decreases. 

A decrease in the currency value decreases its purchasing power, meaning you will spend more dollars to purchase the same commodity in years to come. However, a low inflation rate causes an appreciation in the currency. 

Inflation occurs mainly due to shifts in demand and supply. Demand rises when consumers have more money to spend. It is also caused by increasing wages and low rates of unemployment. Since consumers are willing to pay more, manufacturers increase commodities’ costs, leading to inflation. 

The federal reserve monitors and controls inflation by increasing the federal funds rate, raising the reserve requirements, and reducing the money supply. 

1. Interest Rates

Interest rates can cause currency appreciation and depreciation. Higher interest rates attract foreign investors to a country because they earn more from the high exchange rates of the currencies. That increases the demand for a bill, causing currency appreciation. 

An increase in interest rates lowers inflation by reducing the money supply. When the banks charge high-interest rates on loans, the citizens refrain from borrowing. That reduces their demand, making it harder for manufacturers to increase the costs of commodities. 

Interest rates can also affect foreign exchange rates. However, you can benefit from favorable foreign exchange rates by exchanging your money at Knightsbridge FX. That’s because we make getting your desired currency easier, and the exchange process is straightforward.

• Public Debt

Public debt can hurt a country’s economy. High inflation chances make states with high public debt less attractive to foreigners. The government spends most of its income and taxes to pay the debt instead of investing in economic growth. 

Besides, high public debt can cause a government to print money to pay off part of the debt, increasing the money supply. Even worse, the public debt can make foreigners believe there are high chances of defaulting to pay, reducing their willingness to invest.

However, the opposite is true. A low public debt means the country uses most of its revenues to expand infrastructure and fund investments. That increases economic growth, making the state attractive to investors. In addition, the development of the country’s economy raises the demand for its currency, causing currency appreciation. 

• Speculation

Speculation hypothesizes that the currency will rise in the future using economic forecasting models. If there is an anticipation of an increase in demand for the bill, many people will buy it to make profits. 

That causes an increase in currency demand at the moment, leading to currency appreciation. Anticipating an increase in a currency’s value also attracts foreign investments, leading to economic growth and strengthening the dollar. 

• Political Stability

One of the critical factors foreign investors consider before investing in a country is the state’s political stability. Unstable political climate causes fear to investors because of the uncertainties, reducing economic growth. 

War due to political differences causes businesses to close due to fear, instigating slow economic growth. It can also cause economic sanctions. These affect imports of raw materials and the export of manufactured goods in Canada, affecting economic production. 

When there is political stability, foreign investors feel safe to invest in Canada, increasing economic growth. There is also cheaper importation of raw materials, ensuring steady production of goods and prices. That reduces inflation and causes currency appreciation. 

• Government Policies

The government plays a huge role in regulating the economy, which affects the currency’s value. For example, the government lowers interest rates to encourage investment. Low-interest rates on loans make it cheaper for businesses to borrow, expanding their companies and creating more jobs. That causes economic growth. 

The government could also reduce tax rates to reduce the tax rates, to stimulate economic growth. However, although these can cause currency appreciation, they also have a downside. An increase in money supply can result in inflation in the long run, which can finally lead to a decrease in currency value. 

Effects of Appreciation Currency on the Economy

Appreciation of a country’s currency can negatively and positively affect the economy. Some of the impacts of an increase in a currency’s value are;

• Cheaper Imports

When there is an appreciation of a country’s currency, the implications become cheaper. That is because CAD has a higher value, meaning it can purchase more goods from the United States. 

Cheaper imports benefit businesses that get raw materials from abroad as there is a reduction in the cost of production. That keeps the selling price of commodities steady. Low production cost also increases production, leading to employment and economic growth. 

• Expensive Exports

When a country’s currency is more valuable, its goods become more expensive to foreign buyers. Their currency buys less in Canada due to the high exchange rates. So, an increase in the cost of exports causes a demand reduction, leading to a fall in exports. 

High imports with low exports cause a decline in the trade balance. That can lead to a decrease in economic growth, which affects the currency’s value with its trading partners. 

• Favorable Monetary Policies

An appreciation in a country’s currency can be due to a steady economy. In this case, the government has fewer policies to regulate the economy. The government will be willing to cut interest rates to encourage borrowing, leading to economic growth. 

• Low Inflation

Since the imports are cheaper, there is steady production, and manufacturers do not increase the prices. This causes a steadiness in inflation. Low inflation keeps the country’s currency value high.

How to Maintain a Currency’s Value

A high currency value has more pros than cons, so it is worth maintaining. The government should work on reducing inflation levels. This is because a high inflation rate will reduce the currency’s value. 

The government should also maintain high-interest rates to attract foreign investors. This boosts economic growth and increases currency value. Besides, high-interest rates discourage borrowing, maintaining the steadiness of prices and keeping inflation low. 

A state should strive towards having political stability to make the environment conducive for foreign investors. Another way to maintain a currency’s value is by reducing public debt to ensure that taxes and government funds are invested in expanding infrastructure and supporting investments. 

Final Words

A significant cause of currency appreciation is the demand and supply of the currency. The demand rises when there is speculation of an increase in the currency’s value, causing many people to buy it to make profits in the future. Currency appreciation can also increase due to political stability, economic growth, high-interest rates, and low inflation.