1.5.4 - Exchange rates and competitiveness

Appreciation and depreciation

A currency's value changes relative to another currency, so the direction of the quote determines how the change is read.

Use illustrative quotes from two dates:

Each pound buys more US dollars in April, so GBP appreciates against USD. Correspondingly, USD depreciates against GBP: one dollar buys fewer pounds. If the quote moves from USD 1.50 per GBP back to USD 1.20 per GBP, GBP depreciates against USD.

In the inverse quote, GBP per USD falls from approximately 0.8333 to 0.6667 during the appreciation. Thus a rising number does not always mean the same named currency appreciates; read which currency is being priced. Do not call a currency stronger against every currency from a single two-currency quote.

Import costs

An importer pays for goods or services from another country, so a foreign-currency invoice can change in home-currency cost even when its foreign price is fixed.

An illustrative UK café buys a coffee machine priced at USD 600. Assume no fees and an unchanged dollar price. Using the March and April quotes above:

GBP appreciation reduces the café's pound cost by GBP 100. If it imports inputs regularly, lower costs could increase profit at unchanged sales revenue, or allow a price reduction to attract customers. A lower cost does not itself prove that sales or profit increased: other costs and pricing decisions matter.

GBP depreciation has the reverse effect on this fixed USD invoice: more pounds are required. An importer may absorb the higher cost, reducing profit, or raise its selling price, which could reduce demand. Its options depend on competition and how sensitive customers are to price.

The currency of the invoice matters. If an overseas supplier fixes its price in GBP, a movement against USD does not automatically change the café's immediate GBP payment. The supplier may later change its price, but that is a further decision rather than the direct conversion effect.

Export prices and receipts

An exporter sells abroad, and the effect of a rate change depends on whether its price is fixed in home currency or foreign currency.

An illustrative UK designer sells a lamp for a fixed GBP 100. At the March quote GBP 1 = USD 1.20, its US-dollar equivalent is USD 120. At the April quote GBP 1 = USD 1.50, it is USD 150. GBP appreciation makes the unchanged pound price more expensive for a US buyer. If competing lamps are unchanged in price, some buyers may switch and the exporter may lose sales. GBP depreciation can make the same pound-priced product cheaper in dollars, potentially attracting buyers.

The exporter could lower its GBP price to protect the USD price, but would then receive fewer pounds per sale. Exchange movements therefore create a pricing choice rather than guarantee a particular sales result.

Now suppose another illustrative UK exporter agrees a fixed USD 300 sale. At USD 1.20 per GBP it receives the equivalent of $300 \div 1.20 = 250$, or GBP 250. At USD 1.50 per GBP it receives $300 \div 1.50 = 200$, or GBP 200. The buyer's USD price does not change; appreciation instead reduces the exporter’s GBP receipts. Depreciation would increase GBP receipts for that same fixed dollar sale.

These are different exposures: a home-currency price affects the buyer's foreign price, whereas a fixed foreign-currency price affects the converted home-currency receipt. Do not describe both prices as fixed while also claiming that one changes.

Competitiveness and exposure

International competitiveness is the ability to compete with businesses from other countries, using price and other features customers value.

An exchange movement can change price competitiveness without changing product quality. A cheaper converted export price can improve a business's position against overseas rivals. However, reliability, design, service and brand also influence buying decisions, so demand need not rise merely because the price falls. Rivals may change prices too.

A business can be both an importer and an exporter. An illustrative large UK equipment maker sells pound-priced products abroad and imports dollar-priced components. GBP depreciation could make its exports cheaper for US buyers but raise the GBP cost of its components. The net profit effect depends on imported inputs' importance, sales response and the prices it chooses. A small importer competing with locally supplied shops may face a different result from a business with few imported inputs.

Timing also matters. Existing fixed-currency contracts may delay price changes, and a business may hold inventory bought earlier. An isolated exchange quote therefore does not establish the effect on every current sale or cost. First identify the currencies of costs and receipts, then separate the direct conversion effect from the business's response and the eventual outcome.