How Economic Sanctions Impact Currency Exchange Rates

For decades, economic sanctions have been one of the means by which international diplomacy tries to influence governments to alter their behavior without resorting to the use of armed force. Sanctions could affect virtually any sector: from trade to finance, with the potential to strongly influence exchange rates. In fact, many a time, the link between sanctions and Forex trading might appear more complicated than initially assumed because they can so readily cause shifts in the markets’ sentiment and in investors’ behavior in such profound ways.

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Sanctions tend to immediately affect the country’s financial markets as that may make investors regard them as a sign of political instability or economic hardship. Sanctions may cause capital outflows in the affected country. For instance, if there are some restrictions on its banking system or trade with major economies, foreign investors may not invest in assets of that country because the country’s economy may lose value in the future. This decrease in demand for the currency of a country often causes a drop in value in the Forex market because fewer buyers for that currency are available.

Sanctions also lead to shortages of vital commodities and services because it becomes difficult for the country to trade with the rest of the global market. Sanctions might lead to the country reducing its revenues coming from foreign sources in economies highly reliant on exports such as oil or natural gas. Any form of sanction that touches upon the nation’s capacity to access foreign currency adds to the pressure exerted on the financial stability of the nation. When the economy of a nation is down, the currency takes a knock too and, consequently depreciates against stronger currencies such as the US dollar or euro.

The ripple effects of sanction to a country or nation; this does not in anyway reach the sanctioning itself only to the target country and since it’s a globally competing financial activity, Forex trading, forex market will see that the sanctions placed on other currencies that’s not directly involved in this sanction will eventually become volatile, for instance in case of this is significant player sanctioning, be it from America to its counterpart like Russia, its global market uncertainties will hike. Traders on the Forex market often respond by changing their portfolios, purchasing and selling currencies in the hopes of hedging risk. Such uncertainty can increase the value of a given currency or decrease it according to how investors view the general economic landscape.

Sanctions would also impact the foreign exchange reserves of a country. The sanctioned country would struggle to create foreign currency reserves as barriers erected on trade prevent this. The governments, in an effort to stabilize their economies, may then attempt to manipulate their exchange rates. This results in further volatility in the Forex market since traders will respond to changes in currency values resulting from the artificial adjustments.

Economic sanctions are a significant tool which not only affects the targeted country but also creates waves within the global financial system. Such changes in the currency value and market sentiment make it easier to create new opportunities or risks in Forex trading while trying to navigate through this storm.