PureFX

Are Foreign Exchange Rates Linked to Recession?

Mon 2nd April 2012

Hi there!

In this post I’d like to look at whether foreign exchange rates are linked to recession. This might be useful if you’re about to change currencies, and want to know what factors can help you get a better exchange rate! In addition, if you are changing currencies you might also be interested in fixing the exchange rate with a forward contract, and finding out what influences exchange rates. These can both help you get a better rate.

Linked to Recession?

In short, foreign exchange rates are linked to recession. This is because if a nation goes into recession, it sends a signal that economic conditions in that place are less favourable, which in turn encourages investors to abandon its currency. It’s a little like hearing that the ship you’re on is sinking. Would you want to stay, or would you prefer to move somewhere more safe?

Recession Can Cause Currencies to Fall

For example then, we can look to the downturn that Australia endured in 2011, following the floods in Queensland that resulted in widespread damage to the region. This was of course a horrible event, and we should feel sympathy for the people affected by it. But regarding foreign exchange, the Australian dollar immediately dropped on reports of the floods, as investors predicted it would damage Australia’s economy. Hence in this sense an economic downturn (although not an actual recession) affected the exchange rate.

... and Gain Too!

Of course, the relationship between exchange rates and recessions is not always a straightforward one. In the immediate aftermath of the Fukushima disaster in Japan for instance, the Japanese yen in fact rocketed against most major currencies. This is because, in spite of the fact that the disaster sent Japan into an immediate recession, Japan remains a stable and attractive nation to invest. It turned out that Japan was the safest place to put funds, although the crisis originated there. Hence, in this sense recession can in fact benefit a nation’s currency.

What Next?

So how might you use this information if you’re about to changing currencies? It could be worth looking at which countries are in economic trouble at the moment, as a guide to how the rates might change. Europe for instance is poised to spend 2012 in recession, which might cause it to weaken against the US dollar (here the outlook is more upbeat.) The UK too is still struggling which could limit pound strength. Knowing this, you’re in a much better position to know what rate to expect when you change currencies.

For more great foreign exchange guidance, call us on +44 (0) 1494 671700 or email enquiries@purefx.co.uk. You can also visit us at foreign exchange specialist Pure FX.