Effects On Foreign Currency Exchange Rates
The basic calculation for foreign currency exchange rates is based on the economic principle of supply and demand. The theory means that if there is an increase in the demand for a country’s goods, the value of its currency will increase. In cases where the markets show concern over a country’s economy, its currency value will decrease as investors will start selling off that particular country’s currency. If a country’s economy is devalued, its foreign exchange rate will drop and if there is an appreciation of the country’s currency, the value of the foreign exchange rate will increase.
If a country’s interest rate increases in comparison to other countries, it becomes a good option for investors to deposit funds into that country. The return on investment will increase in that country which will increase the demand for its currency. The higher a country’s interest rates, the more valuable their currency becomes. This process is called ‘hot money flow’ and it is an important factor in the determination of the value of a specific country’s currency.
If a country’s inflation rate was way below that of other countries, its exports become more competitive and this causes an increase in demand for that currency in order for payments to be made. The demand for foreign goods will fall and the citizens in that country will not need to buy imported goods. This indicates that countries with low inflation rates generally experience an increase in the value of its currency.
If goods sold in a specific country attract sales from other countries due to the competitive price rates, it will cause a demand for the country’s goods, hence an increase in its foreign exchange rate.
Balance of Payments
If a country reports a current account deficit, it indicates that the value of its imports exceeded the value of its exports. If the variance can be financed by a capital account surplus, the value of the country’s currency will not be affected. If however, the country’s current account is unable to finance the deficit, there will be a weakening of that country’s currency.
The level of a country’s debt is sometimes the reason behind a variance in a country’s forex rates. In times when the trading markets feel that a country will be unable to service its debt, investors generally become nervous and begin selling off their bonds. This causes panic as well as a devaluation of the exchange rate of that particular country.
If speculators make predictions that a country’s currency will increase at some point in the future, it will increase the demand for that currency as traders would buy it to ensure they make a profit at some point in the future. This increase in demand will cause the currency value to increase. Foreign currency exchange rates movements are not always based on economic indicators. It is sometimes pushed up or down by speculation in the financial markets. It is also the case that news announcements often affect the demand and supply of a currency.
The factors that affect the foreign currency exchange rates of different countries are diverse and as a trader you should keep abreast of happenings in this regard.
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