6 Factors That Influence Exchange Rates

In light of both the tanking of Venezuela’s bolívar and the recent developments in currency wars in Japan and South Korea, here are the six major factors that influence currency exchange rates that every investor should know.

As with many things in macroeconomics, it’s important to note that many of these factors are related to one another.

Government Intervention: Central banks can influence rates by buying or selling the domestic currency.

Inflation: Countries with consistently high inflation rates tend to have lower currency values. This is because purchasing value decreases relative to other countries.

Interest Rates: A rise in interest rates in a country can offer investors a higher rate of return than other countries. As a result, the currency can appreciate relative to other countries.

Current Account Deficits: If a country has a current account deficit, it means that it is spending more than it is earning in foreign trade. To make up this deficit, countries may borrow capital from other external sources, which will in turn help make the domestic currency depreciate.

Government Debt: Countries with high amounts of debt are less attractive to foreign investors due to the chance of default as well as possible high inflation rates. This can decrease the currency’s value.

Speculation: Most trades in the forex markets are speculative trades, which means that sentiment and momentum play big roles. Even if the fundamentals don’t align, the market for a currency can continue soaring or depreciating if traders and governments perceive it should.

Original graphic by: Hiwayfx

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