What Causes the Fluctuation of Exchange Rates?

What Causes the Fluctuation of Exchange Rates?

Exchange rates vary quickly, with some rates rising exponentially and others dropping at an alarming rate. The unpredictability of exchange rates has always been a fact, and this is mainly due to fluctuation of currencies according to demand and supply.

The status of a country’s economy is determined by exchange rates, and it can be a contributing factor to the worth of its imports and exports. If a country’s currency has a higher value in the foreign exchange market, they can import goods and services at a lower price and export it at a higher price. On the other hand, a country with a low-valued currency will have to import at a higher price and export at a lower price.

Several factors affect the variation of exchange rates, and these are usually dependent on the trade relationship between two countries in a currency pair. The following are only a few of the determinants in exchange rate fluctuation, but they provide a better idea on how the forex market flows.

Inflation Rates

If a country has a lower inflation rate compared to others, the value of their currency increases and is considered a sign of a healthy economy. But if a country has a high inflation rate, goods and services will experience a steep increase in prices, and the country’s currency value will decrease. Traders can have a better idea of a country’s inflation rate by looking at inflation reports. Forex trading in the UK is guided by a quarterly inflation report by the Bank of England.

Political and Economic Conditions

Currency value is also affected by the status of a country’s politics and economy. Countries who have a temperate political situation are more attractive to investors. The demand for their currency rises, driving new potential investments to these countries as opposed to countries whose state of affairs is constantly in turmoil.

The market also observes the ongoing conditions and even future predictions of countries’ economy regularly. If a country is predicted to maintain economic stability or development, their currency value may increase. This is why foreign investors often consider how well a country is faring in their relationships with other countries before making any investment decisions.

Terms of Trade

Terms of trade describes the comparison between the export and import prices of a country. The terms of trade are considered to be improving if the export price increases at a higher rate as compared to the import price. This means that the demand for a country’s exports are continually rising, followed by a surge in revenues and eventually, currency value.

In a nutshell

Forex trading in the UK and around the world thrives on the unpredictability of exchange rates since it provides a higher chance of gaining profits. There isn’t always a single reason behind this unpredictability. Most of the time, it’s a combination of the factors mentioned in this list. Needless to say, you need to be mindful of these factors to be a successful forex trader. You are dealing with currencies from the international market, so might as well be aware of the conditions of each country.

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