2023 began with decade-high inflation. Customers in most countries felt the pinch as prices went up across the board, from fuel to tomatoes, thanks to supply-chain disruptions and the Russia-Ukraine war. Inflation became political: people complained about ‘shrinkflation’ (where companies kept the price the same, but reduced the product size), and ‘price-gouging’. Central banks responded with sharp interest rate hikes.

But the tone of central bank governors began to shift in the second half of 2023. Many central bankers now say that inflation has come to manageable levels. The US Federal Reserve in its last meeting on December 12 sounded dovish and hinted at potential rate cuts starting in 2024. However, RBI’s governor Shaktikanta Das remains cautious and says “Any shift in policy now will be premature and risky. Past rate hikes are still working through the economy, and we will closely monitor how that plays out”.

As inflation and interest rate fluctuations impact a country’s currency, we take a look at the performance of major currencies against the US dollar in 2023.

Eurozone currencies do well as economies recover

The US dollar (USD), the most favored reserve currency due to its safe-haven status, has seen some competition from Eurozone currencies in the last year. The euro, the second-largest reserve currency in the world, appreciated by 3.7% against the dollar in 2023. Similarly, the Great Britain pound, another Eurozone currency, appreciated by 5.3% in the same period. 

The recent decline in interest rates as inflation softens, pose a challenge to the dollar, as dollar-denominated assets become less attractive to investors seeking higher yields. The Swiss franc (SFC) appreciated the most (+8.2%) among the Eurozone currencies over the past year. 

Swiss private bank J Safra Sarasin said that the Israel-Hamas conflict has driven investors to the franc as a safer option. Additionally, since late 2022, the Swiss National Bank has been purchasing francs to support its value, lowering the inflationary impact of rising costs of importing commodities. 

Asian currencies remain stable; RBI intervention keeps rupee range-bound

The Indian rupee has been relatively stable,  falling only marginally by 0.5% over the past year. This is mainly due to ongoing intervention by the RBI in both spot and forward markets. 

The RBI's total foreign exchange activity constituted 17% of the overall turnover among banks in the onshore over-the-counter market in October. This led the International Monetary Fund (IMF) to reclassify India’s exchange rate regime to ‘Stabilized Arrangement’ from ‘Floating’. 

The Chinese yuan depreciated by 2% against the dollar in 2023 as the interest rate differential with developed markets stayed high. Structural challenges like sticky inflation, US sanctions and real estate troubles have added to the depreciation in Asia’s biggest economy. The Japanese yen (JPY) weakened by 7.2%, as the Bank of Japan extended its ultra-loose monetary policy, keeping interest rates negative last year. JPY is expected to rise against the USD once the central bank reverses its monetary expansion policy. 

The Russian ruble fared the worst against the dollar, not very surprising to anyone who has been following the politics around the Russia-Ukraine war. The ruble hit a 17-month low as Western sanctions hit the country’s energy exports and the broader economy. As sanctions have tightened and international companies and investments have fled, Starbucks, IKEA and Dunkin’ Donuts have been replaced by local brands like Stars Coffee, Swed House and Donutto. Sanctions on Russian energy exports have contributed to the ruble's 32.8% depreciation against the USD this year, a stark contrast to its 40.2% appreciation last year.

In Latin America, the Brazilian real has appreciated the most against the dollar, rising by 5.5% in 2023. The currency of this commodity-sensitive country has benefited from strong exports earlier in the year, driven by increased global demand and higher commodity prices. In addition, Brazilian policymakers have cut interest rates by 2% since August, with a further 50 bps reduction in the latest policy meeting in December to 11.75%.

The Canadian dollar has also appreciated by 2.4% against the dollar, followed by the Singaporean and Australian dollars at 2% and 1%, respectively. 

Stubborn inflation all over the world has led to disparities in purchasing power and the highest-ever interest rate differences between developed and developing economies. This increased volatility in the forex market throughout 2023. 

According to the IMF, “In emerging market economies, a 10% US dollar appreciation, linked to global financial market forces, decreases economic output by 1.9% after one year.” However, expansionary monetary policies are gaining traction as central banks see reduced inflationary and geopolitical risks. This shift might improve the exchange rate outlook for emerging markets in 2024.