How Inflation Affects Currency and Interest Rates

United States By Christy Lowry Dec 9, 2022

International money markets are highly interconnected. This means that events in one country can have a profound effect on other countries. There have been numerous examples of this in the past such as the global financial crisis in 2008, which started in the US and spread to every major economy. More recently, the COVID-19 pandemic affected the supply chains and economies of almost every country on the planet. However, even without major crises, the price of goods and services and how those prices increase can have a huge impact on other areas of finance—even affecting money transfers.

What Is Inflation?

Inflation is the rate of cost increase over time of goods and services. It is usually measured as a percentage looking back to the same time 12 months earlier. According to the US Inflation Calculator, in the US, the average inflation rate between 2010 and 2020 varied from 0.1% to 3.2%. In 2020, the average inflation rate was 1.2%, which means that goods costing $100 in 2019 would cost $101.20 in 2020. As of September 2022, the inflation rate for the US was 8.2%, a significant jump due to global and nationwide factors made worse due to the years-long pandemic.

What Are Interest Rates?

Interest rates form part of monetary policy which governments and central banks use to control the overall money supply and promote economic growth. The interest rate that you pay on money you borrow is managed by your lender but is usually influenced by the prevailing bank base rate. If you are a saver or investor, the interest rate determines how much you receive from your bank as compensation for you storing your savings with them.

How Does Inflation Affect Interest Rates?

Inflation can impact interest rates because the role of central banks such as the US Federal Reserve is to keep control of inflation. Interest rates and inflation tend to move in the same direction – when inflation is increasing, banks will increase interest rates to encourage people to spend less and save more. In theory, this should reduce demand for goods and services, which helps to contain inflation. When inflation is low, or around the target rate of 2%, banks can keep interest rates lower because there is less upwards pressure on prices so people can afford to spend more.

What Is Currency Conversion?

Currency conversion is the exchange of money from one currency to another. Currency conversion rates are expressed as a ratio of one currency to another, for example, if $1: INR 82.72, every US dollar is worth 82.72 Indian rupees. Currency exchange rates can fluctuate significantly and are affected by many different factors in the economy.

How Does Inflation Affect Currency Conversion Rates?

When inflation is higher, this tends to have a depressing affect on the value of a country’s currency. This is because increased inflation reduces the currency’s buying power, which weakens it against other currencies. The impact of increasing inflation on currency conversion rates is usually downwards.

How Can Inflation Affect Cross-Border Money Transfers?

In a period of increasing inflation, exchange rates can be more volatile. This means that cross-border money transfers can become more costly. If you routinely send money abroad, perhaps the same number of dollars each month, you may start to see the impact of inflation on the amount of local currency that is received. For example, if you sent $300 to India at the end of September 2021, this would have been INR 22,267 whereas the same $300 sent a year later would have been worth INR 24,541. The dollar weakened against the rupee over this time, which meant that each dollar was worth more rupees. Of course, the reverse can also happen. If the dollar is strengthening against the currency you are converting to then your recipient would receive less local currency.

Making Cross-Border Money Transfers Simple

Using a dedicated money transfer app can make it easier to see how much your recipient will get when you send a cross-border payment. You can use the online Currency Converter or Price Estimator on the Western Union website to understand how much local currency will be received and how much exchange fees will be charged.

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