Seven factors that effecting foreign exchange rates

Updated on: 2020-07-20 - 3 mins read

What are the seven factors that affect foreign exchange rates?

Foreign exchange rates, also known as the Forex rate, is one of the crucial determinants which reflects the country’s relative level of economic health.

Needless to mention, foreign exchange rates are the most analyzed as wells as deployed economic measures that impact the actual return of foreign investments and the balance of trade of a country.

In simple terms, exchange rates are nothing but the value of one currency in comparison to another.

Yet, it can be pretty confusing if you send money abroad regularly because of some behind-the-scenes factors that affect foreign exchange rates.

If you are a visual learner, then we have this infographic that lists down the top 7 factors that affect foreign exchange rates.

The seven factors that affecting foreign exchange rates:

1. Inflation Rates:

Fluctuation in inflation rates causes a change in currency exchange rates. Usually, a country with a lesser rate of inflation will see an appreciation in the value of its coinage.

While countries with a frequently low inflation rate show an appreciating currency value, the country with a higher inflation rate naturally experiences depreciation of its currency. Further, it is accompanied by high-interest rates.

2. Interest Rates:

Differentials in interest rate is also one of the factors affecting foreign exchange rates. In fact, forex rates, interest rates, and inflation are correlated in some way. Central banks of the respective countries can impact both inflation and exchange rates through manipulation.

Higher interest rates offer creditors a higher return, which results in more foreign capital, further causing the exchange rate to rise.

3. Recession:

During the recession, a country’s interest rates are likely to fall, which decreases its chances of acquiring foreign capital. As a result, its currency weakens in comparison to other countries dropping the exchange rate.

4. GDP:

Better GDP means the economy’s people are better off with higher wages, and there is an aggregate demand in an economy.

GDP affects the foreign exchange rate in the following way:

1. If the GDP for a country is strong, its currency will rise.

2. If the GDP for a country is weak, its currency will weaken.

5. Government Debt/ Import-export balance/balance of payments:

First, let us understand the government debt: also known as public debt or national debt, is the measure of how much a country owes to the lender country.

If a country has a high government debt, then the chances of getting foreign capital reduce, which leads to inflation.

On the other hand, foreign investors sell their bonds in the open market in such situations, which further results in a decrease in the worth of its exchange rate will follow.

Balance of Payments or BoP is another factor equally responsible for the fluctuations of forex rates.

Here’s How?

In case a country spends more of its currency on importing products than it’s earning through exports, depreciation will occur obviously, which will fluctuate the balance of payments affecting the exchange rate of the domestic currency.

6. Political Stability/Performance:

Believe it or not, the political scenario of a country plays a crucial role in determining the strength of the currency in the mid-term.

Let’s say: if a country is undergoing some sort of a political ambush or coup, foreign investors will tend to avoid investing there and look for a politically stable nation.

As a result, the former country’s economy will experience depreciation in its currency rate, further affecting the economic performance of the same.

7. Stock markets and bond markets/capital outflows:

Stock markets and other forms of capital markets clearly exhibit an economy’s health. The reason behind this is the flow of media coverage and up-to-date information that is based on corporations, institutions, and government entities.

Also, if there is a huge sell-of of securities, it could signal that the future for that nation’s economy has changed in the eyes of the investors.

Conclusion

The bottom line is: the forex market is largely driven by multiple factors that affect exchange rates in one way or the other. Also, it determines the strength of a nation’s currency, which further shows its health at a global level.

So, if you are a regular sender of money overseas, then staying up-to-date with the above factors is advisable. Also compare various money transfer options on Here (https://remitanalyst.com).