7 Key Factors That Influence Foreign Exchange Rates

Being one of the most important determinants of a country’s relative economic health, aside from factors such as interest rates and inflation, foreign exchange rates are the most watched, analysed and manipulated economic measures. They impact the real return of a foreign investment and the balance of trade of a country- such is its importance.
Exchange rates are simply the value of one currency in comparison to another. But due to its volatile nature, it can be quite confusing to someone who transfers money overseas regularly. Here, we have listed 7 factors that influence the constantly changing exchange rates:

1. Interest And Inflation Rates
Inflation is the rate at which the cost of goods and services rise over time. Interest rates indicate the amount charged by banks for borrowing money. These two are linked by the fact that people tend to borrow and spend more when the interest rates are low, which results in increase in costs. These rates are direct indicators of current and future economic performance of a country and can influence the decisions of forex investors and traders through the globe. An increase in interest rate is usually followed by a rise in the value of the local currency. This happens usually because the economy is growing too fast and central banks are trying to slow inflation.

2. Current Account Deficits
The current account is the balance of trade between a country and its trading partners. It describes the difference in value between the goods and services trades with other countries. If a country buys more than it sells then the balance of trade is deficit. It directly affects the exchange rate since a country will need more foreign capital, thus diminishing the demand for local currency. This excess supply of local currency drives down its value against foreign currency.

3. Government Debt
This is the total national or public debt owed by the central government. A country with large amount of government debt is less likely to attract foreign investment and acquire foreign capital, leading to inflation. It may also happen that existing foreign investors will sell their bonds in the open market if they foresee an increase in government debts. This will result in an over supply of the local currency, thus diminishing its value.

4. Terms Of Trade
Terms of Trade is the ratio of export prices of a country to its import prices. When export prices of a country rise at a greater rate than its import prices, its terms of trade improves. This in turn results in higher revenue, higher demand for the country’s currency and increase in the value of the currency. This cumulatively results in appreciation of the exchange rate of currency.

5. Economic Performance
One of the many factors that affect the economic performance of a country is its political stability. A country, which has a stable political environment, attracts more foreign investment and vice versa. Increase in foreign capital results in appreciation in the value of its domestic currency. Such stability also directly affects the financial and trade policy, thus eliminating any uncertainty in the value of its currency.

6. Recession
During a recession, a country’s interest rates are likely to fall, thus decreasing its chances to acquire foreign capital. This in turn weakens the currency of the country in question, therefore weakening the exchange rate.

7. Speculation
Investors demand more of a country’s currency when its value is expected to rise; so as to make a profit in the near future. As a result, the value of the currency rises due to its increased demand. Which in turn results in a rise in the exchange rate as well.

With so many factors involved, exchange rates are subject to fluctuations and that can be quite distressing for people who transfer money overseas frequently. Though watching the rates of a currency corridor can give you a fair idea of the best time to make transfers, it’s best to stay updated about the real-time exchange rates.

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