The best way to understand how the forex market works is to know the reasons that affect the currency exchange rate. One of the most important measurements and determinants of the economic status of a country is the exchange rate of their currency. The demand and supply factors are also one the reasons for the rise or fall of currency rates.
_ The economic factors play an important role in the currency rate, and these could stem from:
_ The economic growth of the country, which is measured in important indicators such as employment status, GDP growth, and retail sales. A sluggish economy would show lower currency rates compared to high exchange rates for countries with booming economies.
_ A high rate of inflation would also show lowered currency exchange rates compared to other currencies. Along the same line, a lower inflation rate of a country makes for higher currency value compared to other currencies.
_ The wider the deficit in a government budget of a country, the lower the exchange rate of its currency. World markets are wary of such information due to the fact that investments become less attractive when there is a rise in default risk involving securities that are in that currency. There will be opposite contrasts of currency exchange rates between countries which will have low currency rates for countries that have shrinking deficits in their government budget, as opposed to higher currency exchange rates for countries that have expanded government budgets.
_ There is a link between exchange rates and interest rates. A country that charges higher interest rates becomes attractive to investors,which will also boost up the exchange rate of their currency. In the same way, a lowered interest rate charged by a country will also lower down their currency’s rate of exchange.
_ A good balance of trade between two countries that would include all money transactions such as interest and dividends, services, and goods will show a clear picture of the current account level of a country. If a country spends more than it earns, which also needs further capitalization, will readily lower the exchange rate of its currency. On the other hand, a country with a good surplus will naturally have a higher currency exchange rate.
When the economic side of a country has been studied, the next important factor to consider would be its political factor. Stable political environments are one of the best reasons that could attract a foreign investor. Numerous foreign investments also raise the exchange rate of a country. In the same manner, the opposite picture of a country in political chaos can drive away foreign investors that would lead to a low currency rate.
The reasons discussed are just the tip of the iceberg. There are numerous and varying reasons that could impact a country’s currency rate which is very important when dealing with forex trading.
