Currency depreciation is a fall in a currency’s value relative to another currency over a stated period. Each unit buys less foreign currency. For a quant measuring an unhedged foreign-currency payment, that can mean a larger cost in the payment payer’s home currency even when the invoice itself has not changed.
The opposite movement is currency appreciation. Always name the currency being valued, its reference currency and the observation dates: “the euro depreciated against the US dollar over the month” is more informative than “the exchange rate fell.”
The dollar invoice that costs more euros
Consider fictional spot quotes at two consecutive month-ends. EUR/USD falls from 1.20 to 1.08 USD per EUR. EUR is the base currency; USD is the quote currency. One euro buys fewer dollars, so the euro depreciates against the dollar. Its signed change in dollar value is
This is a 10% depreciation over that month, not an annualised rate.
Now take a euro-based importer with an unchanged USD 10,800 invoice. Assume it funds the entire payment by buying dollars at the applicable month-end spot quote, with no spread, fees or hedge. The invoice’s euro cost is the dollar amount divided by USD per EUR:
| Funding date | USD per EUR | Euro cost of USD 10,800 |
|---|---|---|
| Initial month-end | 1.20 | EUR 9,000 |
| Final month-end | 1.08 | EUR 10,000 |
The importer needs EUR 1,000 more. Relative to the original euro cost,
Fictional month-end spot quotes, with no fees, spread or hedge. The dollar invoice is unchanged; its euro funding cost rises by EUR 1,000, or 11.11% rounded.
The reciprocal quote, EUR per USD, rises from to . The dollar therefore appreciates by approximately 11.1111% in euro terms over the same month. The two percentage changes have different starting denominators; they need not have equal magnitudes. Quotation units resolve the apparent contradiction. The RBA’s measurement explainer distinguishes bilateral quotes from broader currency measures.
Which exposure gets worse?
For the importer, depreciation raises the euro funding cost of a fixed dollar liability. A fixed dollar asset held by a euro-based investor instead translates into more euros. A fixed euro asset held by a dollar-based investor translates into fewer dollars. Currency denomination and the investor’s reporting currency determine the direction of the translation effect; “a weaker currency hurts investments” is too broad.
An FX forward can fix the conversion rate for a specified future payment. A hedged position therefore need not experience the spot conversion cost illustrated above. Actual cash requirements also depend on executable bid-ask quotes and transaction costs.
Depreciation can put upward pressure on import prices and inflation, but this invoice is not a consumer-price forecast. Sellers may absorb currency costs in margins or delay repricing. The RBA discusses these pass-through and timing limits.
Three distinctions before using the number
- Depreciation versus devaluation. A market-driven fall under a floating exchange-rate regime is depreciation. An official downward adjustment of a fixed or pegged currency’s value is devaluation. Policy can influence a floating currency without every resulting fall being an official devaluation. The Czech National Bank’s explanation makes this regime distinction.
- Nominal versus real. The example measures a nominal currency price. A real exchange rate also accounts for relative price levels. Nominal depreciation alone does not establish an equivalent improvement in price competitiveness.
- Bilateral versus effective. A fall against the dollar does not establish a fall against all trading partners. An effective exchange rate combines a basket of bilateral rates; a real effective rate also adjusts for relative prices. The BIS methodology summary describes its weighted currency baskets and relative consumer-price adjustment. Check the series convention before interpreting the sign.
For quotation and conversion mechanics, continue with Finance Primer: FX, whose full lesson is free with sign-in; the linked public page provides a preview.
Sources
- Reserve Bank of Australia — Exchange Rates and their Measurement, bilateral rates, trade-weighted measures and exchange-rate regimes.
- Reserve Bank of Australia — Exchange Rates and the Australian Economy, import prices, delayed pass-through and foreign-currency valuation effects.
- Czech National Bank — What is the nominal and real exchange rate?, depreciation/devaluation and nominal/real distinctions. Its nominal quotation is domestic currency per foreign unit; the worked example above states its own USD-per-EUR units explicitly.
- BIS Data Portal — FAQ, Effective exchange rates, currency baskets and relative consumer prices.