What is the typical effect on currency when a central bank unexpectedly increases interest rates?

What is the typical effect on currency when a central bank unexpectedly increases interest rates?

• A. The currency depreciates
• B. The currency stabilizes
• C. The currency strengthens
• D. The currency becomes volatile

Answer: (C)

When a central bank unexpectedly increases interest rates, the typical effect on the currency is that it strengthens. This occurs because higher interest rates offer better returns on investments denominated in that currency, attracting foreign capital and increasing demand for the currency. As investors seek to take advantage of the higher yields, they exchange their currencies for the one with the higher interest rate, driving up its value. Additionally, the attractive interest rates may lead to an increase in investment inflows, boosting the overall demand for the currency further. Consequently, the currency appreciates in response to the central bank's decision to raise rates, reflecting the anticipated economic strength and stability associated with higher borrowing costs.

When a central bank unexpectedly increases interest rates, the typical effect on the currency is that it strengthens. This occurs because higher interest rates offer better returns on investments denominated in that currency, attracting foreign capital and increasing demand for the currency. As investors seek to take advantage of the higher yields, they exchange their currencies for the one with the higher interest rate, driving up its value.

Additionally, the attractive interest rates may lead to an increase in investment inflows, boosting the overall demand for the currency further. Consequently, the currency appreciates in response to the central bank's decision to raise rates, reflecting the anticipated economic strength and stability associated with higher borrowing costs.