im reading that the canadian dollar one factor attributing to the decrease of the canadian dollar was the Bank of Canada’s decision to reduce the overnight target rate. just wondering how does reducing the rate cause the country’s currency to depreciate? thanks!
There’s a short term and a long term effect. The immediate effect of a decrease in rates is that people exit the securities to pursue better rates elsewhere. That means they start selling the currency (in this case C$) as they exit, and that bring the exchange rate down. The long term effect is to strengthen the currency, because if PPP holds, over time the C$ money supply should be increasing slower than money supplies with higher rates. In addition, lower interest rates may stimulate investments in productivity, which should make canadian assets perform marginally better. However, all that that takes time. There are lots of other things that affect the exchange rate, but if you assume that they wash out to zero, then the effect is a short term decline in the exchange rate followed by a longer term strengthening.
thx bchadwik