A currency’s value falling concerning another currency is known as currency depreciation. It primarily refers to currencies with a floating exchange rate or a system where the price of a currency is set by the forex market depending on supply and demand.

Currency appreciation, where a currency gains strength, is the reverse of currency depreciation. Based on their market projections, forex traders can profit from both appreciation and depreciation by holding a long or short position.

Why does a currency lose value?

There are numerous causes for currency depreciation. These generally consist of variations in inflation rates, political unrest, and other economic issues. More specifically, listed below are the main reasons why currencies depreciate:

• decreased export earnings
• increased imports
• reduced interest rates for the monetary policy
• Intervention by the central bank
• speculators and traders who sell currencies on the open market
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Illustration of currency depreciation

The value of one currency is always quoted against the other when it is traded. The value of the second listed currency, the quote currency, is stated about the value of the first listed currency, the base currency, which is always worth one.

For instance, if the GBP/USD exchange rate were 1.2700, you would have to pay $1.27 for each £1.

The dollar would be deemed to have declined in value, and the pound would have increased in value if the price of GBP/USD rose from 1.2700 to 1.5000 because more dollars would be needed to purchase the same amount of pounds. This is also known as the pound strengthening and the dollar deteriorating.

Economic Effects of Currency Depreciation

When a nation’s currency gains value relative to other currencies, imported items lose value on the domestic market, and domestic prices often fall. Overseas demand for domestic items tends to decline when domestic goods become more expensive for foreign consumers.

The converse happens when the domestic currency depreciates. Therefore, currency depreciation tends to boost a country’s trade balance (exports minus imports) by increasing the competitiveness of household goods in international markets while decreasing the competitiveness of foreign goods in the domestic market by making them more expensive.

A change in a currency’s value can result in a gain or loss in foreign exchange on the global capital market. The value of financial instruments denominated in the native currency increases due to the appreciation of that currency, whereas the value of debt instruments decreases.

PERCEPTION

A currency’s value decreasing in a system with fluctuating exchange rates is known as currency depreciation.

Weak economic fundamentals, interest rate differences, political unrest, or risk aversion can bring on currency depreciation.

In such circumstances, exporters could cut their pricing abroad since their profit margins rise when faced with a weakening currency. In addition, local businesses will see reduced competition from international sellers due to currency devaluation. But as many Emerging Markets currencies have demonstrated, persistent currency depreciation will likely lead to growing inflation expectations and interest rates.