Chartered Financial Analyst (CFA) Level 1 Practice Exam 2025 - Free CFA Level 1 Practice Questions and Study Guide

Higher inflation generally leads to a weaker currency because when a country's inflation rate rises, the purchasing power of its currency declines relative to other currencies. This means that the same amount of money buys fewer goods and services than before, leading to a depreciation of the currency.

Additionally, if a country experiences persistent high inflation, it may prompt the central bank to lower interest rates to stimulate the economy, making that country less attractive to foreign investors compared to countries with lower inflation and higher interest rates. As a result, there may be less demand for the currency in the foreign exchange market, further contributing to its weakening.

In this context, it’s important to understand that inflation affects not only the prices of goods and services within a country but also the attractiveness of the currency in global markets. Therefore, a consistent correlation exists between high inflation rates and currency depreciation, supporting the conclusion that higher inflation generally leads to a weaker currency.