How currency fluctuations impact international trade
Currency fluctuations are an expected phenomenon that arises from the floating exchange rate system, which is observed by most of the world’s major economies. Multiple factors influence the exchange rates of one currency against another, including the economic performance of a country, interest rate differentials, capital flows, inflation outlook, relative supply and demand for currencies, and more. As these factors change from day to day, so does the value of each currency against other currencies.
The continually changing value of a currency relative to another has a profound impact on international trade, as currency values are deeply intertwined with buying and selling between countries.
Weakened currencies can boost exports but dampen imports
A currency’s relative value against another impacts the country’s economy in a number of ways, including triggering fluctuations in merchandise trade. When a country’s currency becomes weaker, imports into the country become more expensive because a weak currency has less buying power overseas.
While a weak currency can be bad for trade volumes entering the country, it can actually be good for exports. For example, if the pound weakens against the dollar, companies buying British goods with US dollars can afford to buy a higher volume of stock with the same amount of money than when the pound is strong against the dollar. For this reason, currency fluctuations that leave currencies weak can sometimes boost the country’s economy by increasing export competitiveness and making exports cheaper.
On the other hand, currency fluctuations that result in a stronger currency can reduce export competitiveness and make imports cheaper. This can encourage the movement of goods into the country but dampen the volume of exports leaving the country.
Therefore, while currency fluctuations can be good or bad for import or export, overall, significant fluctuations can work against export-dependent industries and can be particularly damaging if the currency remains weak for a long period.
Fall of the pound may boost exports in the short-term
This year, the British Pound fell 16% against the dollar. Headlines were made as the pound reached its lowest-ever value of $1.04 against the US dollar. In comparison, prior to the financial crisis, the pound had been as high as $2. Even in the run-up to Brexit, it fluctuated between $1.45 and $1.70.
This drastic drop in value against the dollar has impacted trade. UK exports have become more competitive in the US, as although this triggers inflation within the country, making goods more expensive, the same goods lose their value overseas. This can trigger short-term economic growth by encouraging exports.
Already, this impact has been reflected in recent reports of the UK’s exports. In July 2022, total exports of goods (excluding precious metals) rose by £2.1 billion (6.7%). This drop was fueled by a £1.3 billion (7.9%) increase in exports to EU countries and a £0.8 billion (5.4%) increase to non-EU countries.
Imports (excluding precious metals), conversely, fell by £0.5 billion (0.9%). This was mostly due to a significant drop in imports from non-EU countries (£0.4 billion, 1.5%).
Overall, currency fluctuations are normal, to an extent. Recent examples of fluctuations that be been seen in the UK are more drastic, and stand to harm industries that rely on imports and exports if the value of the currency fails to bounce back to more normal levels in the near future.
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