A country’s level of economic health is a strong influence on foreign exchange rates. Consider the current exchange rate as a snapshot of a country’s economic stability. If an exchange rate is strong, this is an indication of economic and/or political strength, if an exchange rate is weak, this is an indication of poor economic and/or political stability. Such rates may fluctuate daily with the changing market.
It’s important to understand what determines exchange rates, particularly for companies thinking of sending or receiving money from overseas. Keeping an eye on currency exchange rates can provide a greater understanding of foreign exchange rate variances.
Here we examine some of the key factors that influence the fluctuations in exchange rates and explain the reasons behind their volatility:
1. Political Stability & Economic Performance
As mentioned above, a country with lesser danger of political turmoil is a far more attractive option to foreign investors, therefore drawing investment away from nations with less political and economic stability. Such increase in foreign capital, often leads to an escalation in the worth of its domestic currency. While a country prone to poor economic performance and/or political confusions may see a decline in exchange rates.
2. Inflation Rates & Interest Rates
Interest, inflation and foreign exchange rates are all connected, and impact on one another.
- Interest Rates
Higher interest rates cause a country’s currency to rise, attracting more foreign capital, and creating an increase in exchange rates. Stronger interest rates attract foreign investment, further heightening the demand for a country’s currency.
- Inflation Rates
Changes in market inflation also cause changes in currency exchange rates. For example, a country with a lower inflation rate than another’s will see an appreciation in the value of its currency. And where the inflation is low, the prices of goods and services increase at a slower rate. A country with a lower inflation rate on a consistent basis will display a rising currency value, while a country with higher inflation will see depreciation in its currency and is often accompanied by higher interest rates.
3. Public Debt
Government debt, also known as public debt, is debt owned by the government. A nation with significant government debt is far less likely to obtain foreign capital, resulting in inflation. If the market forecasts spiraling government debt within a certain country, foreign investors will likely sell their bonds in the open market. As a result, the value of the country’s exchange rate will decrease.
4. Country’s Current Account
The current account of a country replicates balance of trade and earnings on foreign investment, gauging all economic transactions between that nation’s people and the people of all other nations. It consists of exports, imports, debt, etc. As goods and services flow from one country to another, the exchange rates of those countries’ currencies tend to fluctuate to promote balanced trade between the two nations.
5. Guesswork & Speculation
Should a country’s currency value be predicted to rise, investors will request more of that currency in a bid to make a profit in the near future. Consequently, the value of the currency will increase due to the rise in demand, which causes a rise in the exchange rate.
Need More Information on Transferring Money Abroad?
Each of the five key factors listed above help to determine the variations in foreign exchange rate. For companies who send or receive money on a regular basis, being up-to-date on such influences will help to better evaluate the best time for international money transfer.
Businesses can prevent potential falls in currency exchange rates by selecting a locked-in exchange rate service. This will guarantee currency is exchanged at the same rate irrespective of any unfavourable fluctuation due to the aforementioned factors.
Specialising in the realms of international currency means FX specialists have the expertise and power to eliminate inflated exchange rates for a business, making international payments up to eight times cheaper than the banks. Tools such as spot contracts, market orders, forward contracts and hedging solutions are often used by an FX specialist to provide competitive exchange rates.
If you’re looking to keep unfavourable fluctuation under control with a fixed rate, contact Central FX, where our friendly FX specialists can help.