3 Key Factors that Determine the Exchange Rate

3 Key Factors that Determine the Exchange Rate
Manila, Philippines - Feb 25, 2018 : Eleveted, night view of Makati, the business district of Metro Manila, Philippines

In your quest to learn what is currency trading, you’re probably well aware that the exchange rate is what ultimately influences its cost.

But just what exactly impacts or determines the exchange rate, let’s take a look.

About Exchange Rates

When it comes to foreign exchange rates, supply and demand ultimately dictate the figures.

As an example, let’s say that there is a high demand for European goods, then you would typically also see an increase in the value of the Euro and vice versa.

Various factors affect supply and demand and thus the exchange rate; however, 3-key factors include inflation rates, interest rates, and speculation, which we will look at in more detail next.

3-Key Factors that Determine the Exchange Rate

Inflation

Inflation refers to the rising general level of cost for services and goods.

Typically, when a country’s inflation is low, it causes its currency’s purchasing power to increase relative to other currencies.

This is partly because, as their exports become more competitively priced, it causes an increased demand to buy their currency to purchase their goods.

Interest Rates

Countries with lower inflation rates also tend to see an increase in their currency’s value because higher interest rates typically follow, which is especially attractive to investors.

For instance, depositing currency in a country with rising interest rates compared to other countries means a higher rate of return, thus causing an increased demand for that currency.

On the other hand, if a country’s inflation rates are much higher than other countries, then the demand for their currency won’t be as high due to the rising costs.

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Speculation

Speculation also heavily dictates foreign exchange rates due to the power of daily turnover in the market.

For example, if there is speculation that the value of a currency will decline, which typically occurs when a country’s political events change, or there is a change in commodity prices, then spectators will quickly trade the currency for one that they feel will increase in value.

This large-scale purchasing of the new currency alerts the markets to an interest rate increase in that region, thus causing the value of their money to increase as an outcome.

Meanwhile, as spectators continue to dump the previous currency to buy the new currency, the previous currency’s supply will increase, causing it to depreciate as the supply of the new currency goes down, causing it to appreciate.

These are just a few of the key factors that determine the exchange rate. In fact, an entity’s public debt, account deficits, and balance of payments also weigh heavily on the value of its currency.

Therefore, if you are serious about purchasing foreign currency, it is important to familiarize yourself with the common factors affecting its value to help make a more confident choice.

In fact, there are many guides from places like Capital.com available to help you learn everything you need to know about currency trading, including how the market works, how to trade currency CFDs on online platforms, and more.

Keerthana

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