How can high real interest rates impact a currency?

High real interest rates typically increase the value of a currency. This phenomenon occurs due to several interrelated factors in the foreign exchange market. When a country has high real interest rates, it offers higher returns on investments denominated in that currency compared to other countries with lower real interest rates. This attracts foreign capital as investors seek to capitalize on the higher yields, which increases demand for the currency.

As investors and institutions convert their money into the currency of the country with the high real interest rate, the demand leads to an appreciation of that currency's value. Additionally, the higher interest rates may signal a strong economic outlook, which further boosts investor confidence and interest in that currency.

In contrast, currencies associated with lower real interest rates may see capital outflows as investors move their funds to higher-yielding markets, resulting in depreciation. This dynamic highlights how real interest rates serve as a critical factor influencing investor behavior and currency valuation in the foreign exchange market.