What factors affect currency exchange rates?

What factors affect currency exchange rates?

Currency exchange rates will fluctuate with various macroeconomic factors such as inflation, interest rates, trade balance, and so on, as well as political climate.

Currency exchange rates are influenced by a number of factors, with some experts listing 5, some experts listing as many as 10. The main variables that will affect exchange rates are inflation rates, interest rates, the trade balance / current account, speculation in Forex markets, and government policies and interventions.

If a lot of countries buy goods from a country, the demand for that currency (or for goods in that currency) will increase and make that currency more valuable. If interest rates are higher in one country, investors and institutions will pile in, demand for the currency increases, and the value of the currency increases.

If a county experiences a slower inflation rate than other countries, it will mean that their money has become more valuable relative to other currencies. Governments can intervene to adjust the value of the currency, such as the Chinese practice of buying lots of US dollars to intentionally keep the value of the Yuan down relative to the dollar.

The political stability of a country, its trade relations and policies, and the international sentiment about a country will all influence the value of a currency as well. The amount of government debt will also influence potential currency investors and speculators.

Speculation in the Forex markets, based around expectations of news or policies or what-have-you, can drive the value of currency up or down quickly. This is not surprising if you remember that trillions of dollars a day change hands on the Forex markets.

It is important to realize that when we look at foreign currency exchange rates, we are seeing the results and implications of more variables than with perhaps any other observable phenomenon on the planet. There are so many factors at play, and so many big players in the game, that it may be wise to sit on the sidelines.