Factors That Affect the Foreign Exchange Market

Factors That Affect the Foreign Exchange Market

The foreign exchange rate also termed as forex rate is an important aspect in stabilizing the economy of a country. It is the market prices that determine how the forex market rates will stand at.

8 Factors That Affect Foreign Exchange Rates

Various factors affect the foreign exchange market. Below are eight factors that affect foreign exchange rates.

Interest Rates

Foreign exchange rates could rise or fall depending on if the interest rates in the forex market rise or fall. An increase in interest rates will appreciate a country’s currency and a decrease of it will depreciate a country’s currency. Appreciation of a country’s currency will consequently give lenders higher rates.

When lenders borrow money from a country at a higher rate, they will let in more capital that is foreign and cause a rise in the foreign exchange rates.

Inflation rates

When inflation occurs, the power of purchasing the said currency declines over a while. Inflation hence disrupts the whole foreign exchange rates of a country. Those countries that have less inflation rate will experience an appreciation in the currency’s value.

Higher inflation rates bring about depreciation in the country’s currency value.

Government’s Debt

Government debt is defined as the state in which a government is owed money that they may have borrowed from another country or institution. Government’s will most of the time borrow money from other countries. Other countries will be using another currency that is different from the borrowing country. This then means that when the foreign currency comes in as debt, it has to go through the foreign exchange rates for the money to be consumable.

This government debt will bring about inflation in the country and hence bring about a decline in their currency. A decrease in the country’s foreign exchange rates will also follow suit. If a country is already under debt, they also have a challenge in acquiring foreign capital.

A country whose government already has a debt will less likely have access to acquire money from a foreign country as they have not yet paid up what they already borrowed.

Country’s Current Account/ Balance of Payments

This includes various transactions that a country involves itself in such as imports, exports, and the debts they have. A country’s current account will reflect the earnings made through earnings on investments done from foreign country’s and their balance of trade. 

A deficit in a country’s current account may come about from the country using its currency to import products rather than using its earnings that come from selling their export, this consequently brings about a depreciation.

Terms of Trade

This is defined as the export prices ratio to that of import prices. The terms of trade of a country increase the prices of its exports at a rate higher than that of import prices. This consequently causes a country’s currency to have a higher demand and the value of the currency increases as well. The result of this is that the country’s foreign exchange rate appreciates.

Recession

A country experiences a recession when they have a decline in their economy. At this time a country’s GDP is down through their trade and industries not doing well. When a country is in recession, its interest rates fall hence foreign exchange rates go downhill giving them no chance to get some foreign capital.

The country’s currency tends to weaken as a result when compared to other countries’ currencies leading their exchange rates to lower as well.

Speculation

If the currency of a country is expected to go uphill, the country’s investors will want to get more of that currency so that they could benefit from it in the future. The increase of the currency’s demand will as a result increase the currency’s value. This will consequently increase the country’s foreign exchange rates as well.

Political Stability & Performance

The politics in a country can also affect the foreign exchange rates. If there is peace within the country and no chaos coming out of the country’s politics, then more investors in the forex market will be attracted.

The presence of turmoil in the country’s political scene will most likely scare aware foreign investors and consequently bring about depreciation in the foreign exchange rates.

Conclusion

This article covered eight factors that affect the foreign exchange rates of a country. The eight factors are interest rates, inflation rates, the debt a government has, a country’s current account/ balance of payments, terms of trade, recession, speculation, and political stability & performance.