One of the most important determinants of a country’s economic health is the foreign exchange rate or FX rate. Exchange rates play a vital role in a country’s level of trade, which is critical to almost every free market economy in the world. As a result, governments are always watching, analyzing, and manipulating FX rates as an economic measure. However, exchange rates do not affect only a country’s economy. They also matter to a business owner. Exchange rates impact the return on an investor’s investment.
A complex interplay of factors, including economic and political factors, influences foreign exchange. Understanding these factors is crucial for investors, policymakers, and businesses that operate in the international market.
In this post, we’ll walk you through the nuances of foreign exchange as we answer the question: What influences FX rate changes? Let’s get into it!
What is Foreign Exchange?
Foreign exchange (Forex or FX) is converting one currency into another at a specific rate known as the foreign exchange rate. The conversion rates for almost all currencies are constantly floating as the market forces of supply and demand drive them.
The most traded currencies in the world are the United States dollar, Euro, Japanese yen, British pound, and Australian dollar. The US dollar remains the key currency, accounting for more than 87% of the total daily value traded.
Furthermore, let’s take a quick look at how exchange rate movements affect a nation’s trading relationships with other nations. A higher-valued currency makes a country’s imports less expensive and its exports more expensive in foreign markets. A lower-valued currency makes a country’s imports more expensive and its exports less expensive in foreign markets. Summarily, a higher exchange rate can be expected to worsen a country’s balance of trade. On the other hand, a lower exchange rate can be expected to improve it.
Factors that Influence FX Rate Changes
Numerous factors affect FX rate changes. Many of these factors are tied to the trading relationship between multiple countries. Keep in mind that exchange rates are relative and are usually expressed as a comparison of two countries’ currencies. Given this, the following are some of the principal factors that affect the exchange rate:
Interest Rates
Central banks set interest rates for their currencies, and these rates have a significant influence on FX rates. Higher interest rates offer lenders higher returns relative to other countries, attracting foreign capital. Consequently, this causes the exchange rate to rise.
However, if inflation in a country is much higher than in other countries, it mitigates the impact of higher interest rates. Additionally, other factors that drive the currency down can mitigate the impact of higher interest rates.
Inflation Rates
Typically, countries with consistently lower inflation rates enjoy appreciation in the value of their currency compared to the currencies of their trading partners. Conversely, countries with higher inflation rates typically see depreciation in their currency.
Public Debt
Countries with large amounts of debt are less likely to attract foreign investment, leading to a depreciation of their currency. This is because large debts may encourage inflation, which can reduce the currency’s value. Also, in the worst-case scenario, a government may print money to pay part of a large debt. However, increasing the money supply inevitably causes inflation. Finally, a large public debt may be worrisome to foreign investors if they believe the country will default on its obligations.
Strong Economic Performance
Politically stable countries with strong economic performance are more attractive to foreign investors to invest their capital. Any country with such positive attributes will draw investment funds away from other countries perceived to have more political and economic risk. Political distress, for example, can cause potential investors to lose confidence in a currency. This may lead to a movement of capital to the currencies of more stable countries.
Speculations
If investors believe that a currency will strengthen in the future, they are likely to buy a lot of that currency, which will increase its value. Conversely, if investors expect a currency to weaken, they may sell off their holdings before the value decreases.
Political events or commodity price changes may cause a currency’s value to fall. So, speculators can sense this fall and respond accordingly. In essence, sentiments in the financial markets can heavily influence foreign exchange rates.
Government Intervention
Governments and central banks may directly intervene in the foreign exchange market to influence the value of their currencies. This can involve buying or selling their currency or foreign currencies to shift demand and supply.
They have the monetary authority to intervene to stabilize a currency by formulating trade policies, printing more money, or increasing and decreasing interest rates.
Current Account Deficits
The current account shows the balance of trade between a country and its trading partners. A deficit in the current account means the country is spending more on foreign trade than it is earning. This means that it needs to borrow capital from foreign sources to make up the difference. Consequently, that can lead to the depreciation of its currency.
How Changera Can Help You with Exchange Rates
Monitoring each of these factors that influence foreign exchange can help you make informed decisions about your business. You may need to make FX payments for your business or even make international transfers for personal reasons.
Whatever your payment needs are, Changera has got you covered. Changera provides businesses with swift international payment settlements and informed foreign exchange insights to help them stay ahead of potential risks. Partnering with a platform like this is one way to help your business and reduce the impact of foreign exchange fluctuations.
Want to stay on top of foreign exchange trends? Download the Changera mobile app on the Google Play Store or App Store today
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