which of the following are short-term drive of currency valuation?
a. surprise changes in interest rates, inflation, and trade
b. surprise changes in interest rates, inflation, and gold
c. surprise changes in relative prices, trade, and gold
d. surprise changes in relative prices, inflation, and trade
The Correct Answer and Explanation is:
The correct answer is: a. surprise changes in interest rates, inflation, and trade
Explanation
Currency valuation, or exchange rate movement, is influenced by a mix of short-term and long-term factors. In the short run, markets are highly reactive to surprise changes in economic indicators and policy decisions. Among the most influential short-term drivers are interest rates, inflation, and trade balances.
- Interest Rates:
One of the most immediate and significant short-term drivers of currency value is a change in interest rates, particularly when the change is unexpected. Higher interest rates tend to attract foreign capital as investors seek better returns, increasing demand for that currency. For example, if the U.S. Federal Reserve unexpectedly raises rates, it often leads to an appreciation of the U.S. dollar. - Inflation:
Short-term changes or surprises in inflation figures can shift currency expectations. If inflation rises unexpectedly, it may erode the purchasing power of a currency and prompt fears of reduced real returns, leading to depreciation. Conversely, lower-than-expected inflation can support currency strength if it suggests a more stable economic environment or prompts central bank action. - Trade Balances:
The trade balance—exports minus imports—can affect demand for a country’s currency. A surprise trade surplus, for instance, means more foreign buyers are purchasing domestic goods, increasing demand for the local currency. Conversely, an unexpected trade deficit can weaken the currency as it signals more currency is leaving the country to pay for imports.
The incorrect options include gold, which is more of a long-term hedge against currency devaluation or inflation, and relative prices, which reflect competitiveness but shift more slowly over time. Therefore, option a accurately captures the primary short-term economic variables that drive currency valuations in foreign exchange markets.
