Exchange rate determines the value of a currency in relation to some other currency. So it is the rate at which one currency can be converted into another currency. Exchange rate constantly fluctuates because of currency moves which are affected by the several factors. This is why it also helps in determining the current economic condition of a country. If a country has strong currency it means that country is economically stable.
As mentioned earlier, exchange rates change constantly. That’s why the people who are dealing the currency exchange, international transfers and those who want to buy travel money must need to monitor it to get the best exchange rate. In this way, it is significant to understand that which factors are affecting the currency moves. So, here in this article, we’re going to share a complete guide explaining leading factors which contribute fluctuations in currency exchange rate.
Major Factors behind exchange rate moves
- Differentials In Inflation
Inflation is a major factor influencing the currency movements. There is an inverse relation between exchange rate and inflation. It means a country with a low inflation rate will see appreciation in their currency because the lower inflation rate increases the purchasing power.
- Interest Rate
Interest rate is another key factor that has a great impact on the exchange rate. It has a direct relation to the exchange rate meaning that if interest rate of a country rises it causes appreciation. It will make a country more attractive so people start deposit money in banks to get a better return. Consequently, it increases the demand for a currency.
- Country’s Current Account
A country account shows its import and exports which is also known as balance of payment. If ratio of imports is greater than ratio of exports then it means the country has a current account deficit. It means country is earning less and spending more. This import and export index has a negative impact on a country’s currency because most countries borrow loan or capital for financing this deficit that in turn devalue their currency.
Exchange rate is uncertain or you can say no one can predict it that what it will stop tomorrow or even next minute. Bu experts forecast currency movements through purchasing power parity and relative economic growth approach. So when it is a rise a currency value is expected, then investors start buying that currency to leverage their profit in future. It will increase the demand for a specific currency. As a result, exchange rate also increases. It’s all about sentiments. For example, the value of Australia dollar is expected to rise in near future so the foreign investors try to buy more Australian currency thinking that it is the best money exchange rate because it’ll be expensive at that time.
- Socio-Political Stability
The social and political conditions of a country greatly impact the value of its currency. A country which is facing internal wars and a political turmoil, of course, cannot attract the foreign investors. So investors start drawing away their investment and move toward more stable countries. As a result, the country will see depreciation in currency.
- Government Debt
Countries with higher debt in their saving account have a high inflation rate. It reduces the purchasing power as investors do not prefer investing in such countries. The foreign investors start trading their bonds in the market because of debt crisis fear. The high debt leads to currency depreciation.
- Economic Recession And Performance
Basically, exchange rate depicts a country’s economic growth, allowing you to determine that whether a country is prosperous or not. A country facing a deep recession is less attractive for the investors as it is linked to the interest rate. So it weakens the currency of a country that further depreciates the exchange rate. However, there are some other factors which also contribute to it.
- Currency Intervention
When the monetary policy makers or authorities of a country intervene in the Forex market in order to achieve some objectives is known as currency intervention or government intervention. Sometimes policymakers or government take steps to control the inflation, maintain financial stability and competitiveness. Countries stabilize exchange rate by devaluing their currency, making their exports more competitive.