Understanding The Foreign Exchange Market

The economy is changing, so watching the inflation rate is becoming more important that watching the exchange rate.

Jamaicans have generally accepted “exchange rate stability” to mean a slow rate of depreciation punctuated by occasional bouts of appreciation. As a completely rational response, many Jamaicans hoarded foreign exchange if the rate depreciated quickly.

This was a widespread response to the fact that the exchange rate, driven by a large and persistent current account deficit, remained overvalued for a long time and moved mainly in one direction only.

Those conditions have changed, and the era of a sustained one-way drift in exchange rate is over.

Jamaica has at last corrected the underlying problem, but correcting it doesn’t mean the opposite – a rate that constantly appreciates – or a rate that is static at any particular level.

What is emerging is a normal foreign exchange market, one in which the exchange rate moves in BOTH directions in the short term, in response to current market conditions or sentiment.

What this new trend means is there is no automatic need for alarm if the rate depreciates, conversely, there is also no need for excitement when it appreciates. Either way is completely normal, and it is actually supposed to move in BOTH directions.

As long as the 2-way movements mostly cancel each other out over annual business and seasonal cycles, then they won’t affect inflation significantly and it shouldn’t matter seriously if the rate ends up a bit above or below where it was the year before.

Therefore, think long term and plan accordingly.

diGJamaica tracks the F/X rate weekly and the inflation rate monthly, keep up to date using our Economic Indicators Dashboard. Clink on the links to see graphs showing longer terms trends for these indicators.

Information courtesy: The Bank of Jamaica