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Vital Factors that Affect Foreign Exchange Rates

Written by 9rules Blog on May 14, 2016

forex rates

Foreign exchange rates change several times round the clock. The rates are known in the foreign exchange market where currency is being traded between buyers and sellers.

Basically, the exchange rate determines a country’s economic health. As such, it is closely monitored, analyzed and even manipulated.

It should be understood that when the values of two currencies change, the exchange rate also fluctuates. Normally, a currency is considered more valuable when its demand is greater than the available supply. Demand for a currency is influenced by two things – higher transaction demand for money and increased speculative demand for money.

Transaction demand is closely linked to the level of business activity and employment in a country as well as its gross domestic product (GDP). Speculative demand, on the other hand, is related to interest rates. This means that when interest rates are high, there will be greater demand for that particular currency.

Today, it is easy to know the value of a particular currency. One just needs to connect to the internet, use an online currency converter and get results instantly. Whether you want to check the rate of 1 Euro against the U.S. dollar or convert 1 Aud to USd, these online currency converters are indeed very useful to consumers.

Factors Affecting Forex Rates

Inflation

A country’s currency value rises when it has a lower inflation rate. On the other hand, a higher inflation would mean a depreciating currency accompanied by higher interest rates.

Countries that have low inflation in the last half of the 20th century include Japan, Germany and Switzerland. The U.S. and Canada got included in the list a bit later.

Interest Rates

Interest rates also influence exchange rates and inflation rates. When they are at a higher level, they attract foreign capital thereby resulting in a rise in exchange rate. Lenders, for their part, also benefit through a higher return.

Speculation

The exchange rate worldwide is also directly affected by speculations. When speculations are high that the rate will go up in the future, there will also be a higher demand for currencies resulting in an increase in their value.

Government Debt

Government or public debt normally causes inflation rate to go up and a large debt is never attractive to foreign investors. If foreigners believe the country is at risk of defaulting on its financial obligations, their worry translates to low interest in owning securities.

In addition, when public debt is large, it means it will be serviced and paid off with cheaper real dollars in the future. As such, the country’s debt rating is a vital determinant of its exchange rate.

Political and Economic Stability

Foreign investors are often attracted to put their money in countries with stable political and economic climate. Countries with these positive attributes are more likely to gain investment funds compared to those experiencing political turmoil which can lead to lower or even loss of confidence in a currency.