What factors affect exchange rates?

Exchange rates are significant indicators of a nation’s economic health. It is an important factor in a country’s trading relationship with the world. Learning the factors that affect it is essential knowledge for all market participants as it is the basis of the Forex market.  Here are the factors that affect the exchange rate:

1) Interest Rates

Interest rate is part of a loan that serves as interest or payment for the loan that is typically expressed in percentage. Higher interest rates gives lenders increased returns for their loans and thus it attracts foreign investors to loan capital because of the better profit. Exchange rates also rise because of this. Lower interest rates means lower exchange rates.

2) Inflation Rates

Inflation is the overall hike the prices of goods while the purchasing power declines. Lower inflation in a country means a higher currency value therefore an increased purchasing value versus other currencies and thus a lower exchange rate. Higher inflation means vice-versa. The exchange rates is influenced by the rise and fall of inflation.

3) Government Debt

The government debt or public debt is a debt owed nationally by the central government to other countries or international banks. A bigger government debt attracts less investors and thus less capital. This then leads to inflation which will increase exchange rates if it gets higher.

4) Recession

Interest rates have a higher chance of dropping in times of recession. This is a way for central banks to help the economy. Therefore, the increase in interest rates means a hike also in the exchange rates.

5) Speculation

Speculation is the expected outcome for the economy. Market participants may expect a country’s economic health to rise or decline. In any case, this speculation creates actions. For example, an investor who sees that there is a great anticipation for a currency to appreciate will buy many shares of that currency. The demand has increased meaning so will the exchange rates. The opposite is the same for lower exchange rates.

These are just some of the factors that affect the exchange rate. Learning them is an important knowledge when tackling the markets.