How does inflation impact exchange rates?

Inflation can impact exchange rates in several ways. One way is through the interest rate differential, which is the difference in interest rates between two countries. If a country has a higher rate of inflation than another country, its central bank may raise interest rates to curb inflation, which can attract foreign investment and strengthen its currency. Additionally, if a country’s inflation rate is higher than other countries, its goods and services will become more expensive relative to other countries, making its exports less competitive, which can weaken its currency. In summary, high inflation can lead to higher interest rates and decrease in competitiveness, which can cause a country’s currency to depreciate.