not necessarily high inflation but depreciation. but the question does not mention interest rate parity - covered or uncovered that is what confuses me
I think the problem of this question is that it does not say appreciation relative to which point. If you look at the figure in asset market approach. When there is an interest change, there is an immediate change of exchange rate, then it starts to revert back to PPP level. I think the question is trying to ask about the effect of reverting to PPP level. But it does not clearly say that here.
I guess what this question is looking for is real interest rate… It says that Nominal interest rates are declining along with inflation rate. So I suppose we have to assume that real interest rate is constant and also attractive given inflation is trending downwards.
They should ask “Assuming that Uncovered IRP holds,…”, because there is plenty of evidence that it doesn’t.
I thought this was a relatively unambiguous and striaghtforward question.