Factors Governing Foreign Exchange Rates
Foreign exchange market, also known as FX or forex, is the largest market in the world. Fluctuation of foreign exchange rates is the most important parameter in forex market. Foreign exchange rates play a major role in a country’s level of trade, which is critical to all free market economy in the world. Exchange rate shows the country’s level in regard to economic health thus foreign exchange rates are most watched economic measures. We will see several important factors which influences the foreign exchange rates.
However, before we see these factors we need to get a brief idea that how fluctuations in foreign exchange rates affect the trading relationship between two nations. If your country’s exchange rate is higher than currency exchange rate of relative country, your exports will be more expensive and imports will be cheaper in the forex market. Viceversa lower currency exchange rate makes your country’s exports cheaper and its imports more expensive in forex market. Higher currency exchange rate lowers nation’s trade-balance and lower currency exchange rate increases it.
There are number of factors which determine foreign exchange rates, in turn trading relationship between two nations. Foreign exchange rates are actually the currency ratio of two nations and below are some important factors which affects on this currency rate.
However, before we see these factors we need to get a brief idea that how fluctuations in foreign exchange rates affect the trading relationship between two nations. If your country’s exchange rate is higher than currency exchange rate of relative country, your exports will be more expensive and imports will be cheaper in the forex market. Viceversa lower currency exchange rate makes your country’s exports cheaper and its imports more expensive in forex market. Higher currency exchange rate lowers nation’s trade-balance and lower currency exchange rate increases it.
There are number of factors which determine foreign exchange rates, in turn trading relationship between two nations. Foreign exchange rates are actually the currency ratio of two nations and below are some important factors which affects on this currency rate.
- If nation’s inflation rate is lower then purchase power increases in comparison to other countries with high inflation rates. Lower inflation rates are always accompanied by higher interest rates.
- Central banks declare the interest rates of any nation. High interest rates means high return which directly influence the currency rate to go high. Interest rate, inflation and foreign exchange rates are highly correlated. In case, the inflation rate of the nation goes higher than interest rates are lowered which ultimately decreases the nation’s foreign exchange rates in forex market.
- Current trade account between two nations is reflected by payments of goods, services, interests and dividends. There will be a shortfall or deficit in current account if country is spending more than earning. In such case, more foreign currency is needed to cover this deficit. The higher demand of foreign currency lowers the foreign exchange rate of the nation.
- Foreign investor also analyze about the government projects and the funding available to complete such projects before they invest in any country. If the government has already borrowed fund from other countries, the inflation rate will become high and foreign investors never prefer to invest in such country. This is one of the most important factors which impact on foreign exchange rates of particular country.
- Import and export ratio of the country, in relation to current account, plays a vital role in determining the currency exchange rate of the country.
- Foreign investors seek the companies with consistent good economic performance. They also look for strong and stable political platform. Less political and economic risk attracts more investors and in turn more foreign currency from the other countries. In this case, higher currency exchange rate of the country and the opposite of this decrease the currency exchange rate.
