What Are The Effects of Recession on The Foreign Exchange Rates?
Hi there! In this post I’d like to explain what are the effects of a recession on the foreign exchange rates. This might refer to a global recession, such as the one we witnessed in 2008, or a more localised recession, such as the one the Eurozone is enduring at present. Both kinds of recession impact the exchange rates in different ways.
In terms of how this post might be helpful meanwhile, it could be useful to know if you’re planning a foreign exchange transaction, and aren’t sure what the effect of the recession in Europe might be on the euro, or if you’re just looking for the best time to change currencies.
Global Recessions and the Foreign Exchange Rates
On a global scale, recessions tend to favour currencies that are perceived to be safe and secure. This is because investors want to keep their money where they feel it’s not at risk, and stand little chance of losing it because their investments go bankrupt or something else untoward. Examples of currencies perceived to be stable (the technical term is a safe haven) include the US dollar, Japanese yen, and Swiss franc.
These currencies are believed safe havens because the economies they belong to are large and stable, unaffected (to some extent) by changes in global commodity or fuel prices. In the last eighteen months, the UK pound has also gained safe haven status, as a currency offering reprieve from the Eurozone debt crisis.
Examples of The Effect of Recession on The Foreign Exchange Rates
So what exactly happens to the exchange rates during a recession? In short, those currencies perceived to be safe havens (as I previously listed) gain in value against those considered riskier, as investors on the foreign exchange market flock to put their funds in a stable location. For example, during the Fukushima nuclear disaster in Japan last year, the Japanese yen in fact rocketed up against a basket of currencies, because the Japanese economy is considered a large and stable investment. This is quite obviously in spite of the fact that the crisis originated in Japan!
Equally, you may remember hearing last year how the Swiss National Bank was forced to peg the franc against the euro at 1.20, to prevent the huge foreign inflows that were dragging down its value. These inflows were arriving because the Swiss economy is considered stable, certainly compared to the Eurozone.
Smaller Recessions and The Foreign Exchange Rates
In non-global recessions meanwhile, such as the one the Eurozone is enduring at present, the foreign exchange rates tend to go against the currency involved in that recession. Hence, since the beginning of 2012 when Europe began contracting, the euro has reached an 18 month low against the UK pound and looks set to remain there for the duration.
In the other words, if a country is involved in a recession (or any other disappointing piece of political or economic news for that matter!) its currency is bound to suffer.
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