Currency Move Based on Real Interest Rate Movement

Question

This may be a dumb question but I feel I see a different answer every time so I wanted to ask all of you what do you think.

If the interest rate differential moves or is expected to increase, would the currency of the increasing interest rate appreciate or depreciate? In practice, I think the currency should appreciate due to new flows coming in but I have read that in theory, the currency should depreciate. What is the real answer? There are many ways you could think about this such as the currency depreciating due to the higher rate decreasing GDP etc etc but in context of the CFA, should it depreciate or appreciate?

vincentt · Answer

@rrestrepo17‌ I'm not too sure if this answer your question:

In economics topic, when interest rate goes up the currency should depreciate, the I/R is mainly refer to the inflation.
When real interest rate goes up, the currency should appreciate as it attracts investors.

However, I think in a longer run the currency will eventually depreciate as when the currency appreciates other countries would find it very expensive to import from this country with appreciating currency and eventually there will be a trade deficit hence currency will depreciate.

That's as far as I know but I could be wrong.