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
Lower inflation rates typically mean that a currency’s value will appreciate relative to other currencies with higher inflation rates. This is because lower inflation rates cause interest rates to rise. A higher interest rate will attract more foreign investment in a country which in turn increases the demand for its currency. While this often causes the currency to appreciate, it is not always so finely cut.
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.