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Understanding Foreign Exchange Rates and the factors impacting them
A country’s currency exchange rate is an important measure of that country’s level of economic health. Exchange rates are influenced and monitored by the government of that country. Apart from measuring the health of the country’s economy, exchange rates affect investor’s returns and the country’s level of trade.
Exchange rates can be defined as the rate at which one country’s currency can be exchanged for another country’s currency. The main reason why people would like to do currency exchange is to pay for services or even buy goods.
While we might think that exchange rates only affect the government and key economic players, they also affect small scale traders because of their impact on the return on investment as this is most important ever to a number of people.
Imports and exports are the staples of international trade
A country that conducts a lot of international trade might be growing while it might also be negatively influencing its trade. This is so because, when a country imports more than it exports, it is likely to cause an imbalance of trade and consequently lower its exchange rates in the trading platform hence devaluing its currency.
On the other hand, when a country exports more, there is a high demand for its goods. When demand is high, there is a likelihood of the product prices to increase leading to that country’s currency value appreciating.
Having understood how currencies appreciate and depreciate, let’s look at factors that impact the rates of forex exchange rates.
The political stability of a country
A country that is politically stable has a great environment for foreign investments and the other way around. This affects the economic performance of that country because with foreign investors coming in, foreign capital increases in the country hence the high demand for that country’s currency.
This results in the appreciation of the local currency. Apart from an increase in the value of the currency, the country is able to reduce the chances of fluctuating values because of the strong trade policies.
Depending on a country’s economic performance in the recent past, people can predict what is likely to happen in the near future. When investors are expecting the currency of a certain country to appreciate in value, they will all be trying to buy more of this currency. With the increase in demand in that currency, its prices increase hence an increase in its exchange rates. However, as the word speculation says, they are unsure of the prediction and the positive outcome is not always guaranteed.
Debt owed by the Government
Just like exports and imports, the influence of a country’s debt is the same. When a country has so much debt, it reduces its opportunity of attracting foreign investors. Those already invested in the country will sell their bonds to avoid the effects of inflation that is caused by too much borrowing.
This, in turn, will lead to many people selling this country’s currency hence an oversupply in the market. When there is too much of something in supply than its demand is, the prices of the product tends to decrease. This being the case, the price of the currency decreases hence a decrease in its exchange rates.
A country’s terms of trade
When a country has very favorable terms of international trade, it tends to attract more buyers for its products, this leads to an increase in exports. If the country is able to maintain a lower import price compared to its export price, it results in higher revenues. The country’s currency is in higher demand hence an increased value as well as exchange rates.
Borrowing interest rates
The key player in this is the central bank. A country with higher interest rates can offer a higher return to lenders. This will attract foreign investors causing the exchange rates to increase due to increased demand for the currency.
As we can see, exchange rates are influenced by many factors in the economy and while it might be difficult to understand them, investors should be always on the lookout for them.
Understanding the relationship between currency values and exchange rates on the trading platform will greatly impact on their return on investments.