The Foreign Exchange Rate is one of the most important means through which a country’s level of economic health is determined. It is the rate at which one country’s currency may be converted into another. So it is important to understand what determines exchange rates.
Currency exchange rates are the basis used to determine economic levels of different countries. The stability of a country is measured by the fluctuation of these exchange rates. If they keep on varying extremely, the country is very unstable. For this reasons and considering that they are national matters, they are important and hence they are closely monitored and analyzed. For those willing to do overseas trading, the recommendation is to first study the exchange rates and the way they keep on changing.
Exchange rates are the charges for exchanging currency of one country for currency of another. This is like buying money using money but with different monetary values. These keeps on changing on daily basis according to the market forces of supply and demand that vary in different countries daily. The exchange rates are determined by the many market influencing factors. Some determinants and influences of exchange rates are discussed below.
Inflation is the rate of change of prices (as indicated by a price index) calculated on a monthly or annual basis. This causes continuous increase in products within a country. Generally, lower and stable inflation rates show that the currency value is rising. The purchasing power usually goes up relating such currencies to the unstable economies. Countries with lower inflations usually end up becoming developed countries with time. Such include japan, Canada etc. that followed the same suite. Those economies experiencing high inflation rates usually cause depreciation of the currency. Higher interest tares also accompany them.
This is the percentage of a sum of money charged for its use. It is very highly related and go in hand with exchange rates and inflation rates. When these rates vary, they cause changes in both the inflation rates and currency exchange rates. These rates are usually varied by the banks such as central banks that have control over money supply. High interest rates usually give the lenders and the lending institutions a high return compared to others in a different country. This in turn helps to attract the foreign capital causing exchange rates to go up. This means that if the inflation rates are high in comparison with other countries, then the exchange rates will have to go down.
The politics in a country determines a lot in that particular country. The investors generally will go for the peaceful and good performing economies. This is to ensure that they are not seeking for losses. They seek for countries they can trust and have confidence in. Such countries will have the advantage of many investors and their exchange rates will definitely go up.
Country’s Current Account / Balance of Payments
A country’s current account reflects balance of trade and earnings on foreign investment. It consists of total number of transactions including its exports, imports, debt, etc. A deficit in current account due to spending more of its currency on importing products than it is earning through sale of exports causes depreciation. Balance of payments fluctuates exchange rate of its domestic currency.
When a country experiences a recession, its interest rates are likely to fall, decreasing its chances to acquire foreign capital. As a result, its currency weakens in comparison to that of other countries, therefore lowering the exchange rate.
Terms of Trade
Related to current accounts and balance of payments, the terms of trade is the ratio of export prices to import prices. A country’s terms of trade improves if its exports prices rise at a greater rate than its imports prices. This results in higher revenue, which causes a higher demand for the country’s currency and an increase in its currency’s value. This results in an appreciation of exchange rate.
If a country’s currency value is expected to rise, investors will demand more of that currency in order to make a profit in the near future. As a result, the value of the currency will rise due to the increase in demand. With this increase in currency value comes a rise in the exchange rate as well.
Government debt is public debt or national debt owned by the central government. A country with government debt is less likely to acquire foreign capital, leading to inflation. Foreign investors will sell their bonds in the open market if the market predicts government debt within a certain country. As a result, a decrease in the value of its exchange rate will follow.
All of these factors determine the foreign exchange rate fluctuations. If you send or receive money frequently, being up-to-date on these factors will help you better evaluate the optimal time for international money transfer. To avoid any potential falls in currency exchange rates, opt for a locked-in exchange rate service, which will guarantee that your currency is exchanged at the same rate despite any factors that influence an unfavorable fluctuation.