Factors That Influence Forex Rates
Inflation and interest rates are important to determine a country’s economic health level, but forex rates can be said to be one of the most important factors. A country’s level of trade is critical to its economic health and exchange rates have a vital role to play in this regard. It is for this reason alone that forex rates are constantly analysed, watched and manipulated by governments. On a smaller scale, exchange rates can affect the portfolio of investors.
Exchange rate swings can affect a country’s trade relations with other countries. If a country’s currency is high, its export become more expensive and imports become cheaper. A lower currency reduces the cost of exports and increases the cost of imports. This indicates that a higher exchange rate is responsible for a lower balance of trade, while lower forex rates would increase the country’s balance of trade.
Forex Rates Determinants
There are several factors that affect forex rates and they are all based on the trade relations between two countries.
A general rule is that countries with inflation rates that are consistently lower show an increase in their currency value. This is because their purchasing power will increase as compared to other currencies. Countries that have a higher inflation rate normally experience a decrease in their forex rates compared to the currencies of the countries they trade with. In these cases the interest rates will be higher too.
Foreign exchange rates, inflation and interest rates all have a correlation to each other. National banks who manipulate interest rates influence the exchange rates as well as inflation, and the change of interest rates has an impact on forex rates and inflation. Higher interest rates make it worthwhile for lenders in an economy to obtain a higher level of return in relation to other countries. This attracts foreign investment which causes an increase in the forex rates. The opposite applies in there is a decrease in interest rates. Lower interest rates will normally decrease the value of currency.
Countries who undergo projects and require funding for its government spending will often participate in huge amounts of deficit financing to pay for these activities. Although this action will bring stimulation to the domestic economy, these countries that have large public debts and deficits are unattractive to foreign investors. The reason for this is that large debt levels increases inflation. If inflation is at a high level, the debt will be settled with real currency that has less purchasing power in the future.
In dire conditions, a government may choose to print more money in order to settle a large debt, however, the increase of money supply will almost always cause inflation. The other disturbing factor in this case is that if a country is unable to service the deficit that it is experiencing via domestic measures, then it will have to increase its supply of securities to sell to other countries, which means the value of these securities are lowered.
There are several other economic, market analyst, price action and political factors that influence currency rates.
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