6.4.2—Floating exchange rate

Under a floating exchange-rate system, the currency price is mainly determined by market demand and supply rather than a fixed official parity.

Higher demand for exports, domestic assets or the currency’s interest-bearing deposits tends to appreciate it; greater demand for imports or foreign assets tends to depreciate it. Expectations can move the rate before the underlying trade changes.

If overseas investors expect higher returns in a country, demand for its currency may rise and the currency appreciates, potentially making exports less competitive later.

Floating does not mean “random” or “without central-bank influence”; intervention and interest decisions can still affect demand and supply.