# Interest rate and inflation rate differential?

I’m getting confused from the Schewser books in regards to the interest rate differentials and inflation rate differentials. What do each of the differentials tell you in regards to valuation for currencies or anything else? I feel like sometimes I hear Schewser saying the inflations differential affects the appreciation or depreciation of the currency and sometimes I hear Schweser use the interest rate differential affecting the currency. I’m so confused on which differential explain what? Can anyone please clarify for me? Thanks a bunch

Higher Inflation: Depreciation Higher real interest rate: Appreciation Higher nominal rate: Depreciation I just always get f*cked by the notation. Can anyone shed some light on this? I saw AUD:USD as 1.5 (or something), thought it meant 1.5 AUD per USD but somehow it was the other way around. I’m seriously missing something in that area…

Higher inflation leads to depreciation in the currency with the high inflation rate. Higher nominal rate has the same effect. You can think of nominal rate as the sum of real rate and inflation, so higher nominal rate suggests higher inflation, => depreciation in the currency with the high nominal rate. And yes, higher real rate would stimulate investment demand in the currency so would lead to appreciation. And yes, the notation sucks and needs to be punished… but AUD:USD is the same thing as USD/AUD or dollars per one Aussie dollar. When you see the colon, always think base currency:counter currency. Whenever I see those expressed with the colon I immediately write down USD/AUD = x just to make it clear in my head which is the base.

If you’re uncomfortable with the X:Y notation, just flip it around and put it as Y/X when you see the question.

Problem is, for me at least, I read the : as /. Since back in highschool (Europe) : was the notation for dividing. So to me it says: AUD:USD is 1.5 as AUD divided by USD is 1.5. Hence the confusion. So for clarification: You can always assume AUD:USD is actually USD/AUD? Then I just have to print that in my head although it can be hard when you have : is division in your head Thanks guys for the explanation. I’ll follow you blindly and hopefully it should decrease the amount of errors I make!

Yep. stamp that one in there. it can also help to do the smell test if you’re somewhat familiar with real-world exchange rates. i.e. if they give us USD:JPY = 105, you know one yen doesn’t buy you \$105, it’s the other way around. This can be useful, although they sometimes give obscure currencies, or fake ones.