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Top Factors that Influence Exchange Rates
Every day, about $10 trillion of currency is exchanged on the global markets. Exchange rates are arguably the most-watched as well as analyzed economic measures across the globe. Besides, they’re a crucial indicator of a nation’s financial health.
However, there’re a plethora of forces behind the exchange rate movements, and you must have an understanding of how they affect a country’s trading relationship with others. A higher-valued currency simply makes the imports of a country less expensive while the exports are costly.
On the other hand, lower-valued currency makes imports of a country more expensive and the exports less expensive. Therefore, higher exchange rates worsen a nation’s balance of trade, and a lower exchange improves it.
So, what fuels the changes in this not only extremely liquid but also busy market? Why are exchanges rates between the countries always in flux?
Here’re the six factors that influence exchange rates;
The interest rate’s changes affect the currency value as well as the dollar exchange rate. Interest rates, inflation, and forex rates are all correlated. An increase in a country’s interest rates results in its currency appreciating since the higher interest rates provide lenders higher rates. The scenario attracts more considerable foreign capital that causes an increase in exchange rates.
Government debt merely is national debt or public debt owed by the central government. Some countries fund projects to stimulate the domestic economy, but that leaves the country with a significant debt to pay.
Countries with massive debts and deficits are less attractive to foreign investors. It’s a situation that leaves such nations unlikely to get foreign capital which leads to inflation. If the country can’t service the debt via domestic means, then the only way is to raise the supply of securities for sale to the foreigners, lowering their prices.
The change in market inflation leads to changes in currency exchange rates. A country with a low inflation rate than another country results in its currency’s value appreciation. With low inflation, prices of commodities increase slowly.
Typically, a country with a lower inflation rate sees an increasing currency value while that with higher inflation exhibits depreciation in the currency as well as sees higher interest rates.
Balance of Payments
A nation’s current account is a true reflection of trade as well as earnings on foreign investment. Usually, it involves the total transactions that include imports, exports, and debts. A deficit in the current account as a result of spending much on imports than exports leads to depreciation.
It then means that a nation needs more foreign currency than what it gets from the sales, and supplies much of its currency than how much foreigners demand.
Terms of Trade
Like the current accounts, terms of trade is simply the ratio of the export prices to that of the imports. The terms of trade, a country improves when the export prices grow at a rate higher than the import prices.
The results are that the revenue increases, causing a high demand for its currency as well as an increase in its value. The outcome is an appreciation of the exchange rate.
Strong Economic Performance
It’s a no brainer that foreign investors will go for countries with stable and robust economic performance to invest. Positive attributes of a country is an attraction for investors while those countries with economic and political risk repel foreign investors.
If you’re planning to receive or send money, staying up-to-date with such factors is a priority as they determine foreign exchange rate fluctuations. These factors such as recession, speculation, inflation, and interest rates all determine the real return of an exchange rate of currency which any investor’s portfolio holds the majority of the investments.