DETERMINANTS OF EXCHANGE RATES
Exchange rates shape the way we do currency trading, being one of the vital determinants of a country’s overall economic condition and trade level. Since forex rates influence global markets, it impact a portfolio as well. Several aspects affect exchange rates, but we will focus on the primary factors.
The current account depicts all payments between nations for interest, dividends, products, and services. Essentially, a country supplies more of its own currency than foreigners seek for its goods, and it warrants more foreign currency than it accepts via exports. A positive account balance signifies the country is a net lender, while a negative account implies the nation is a net borrower.
Economic and Political Soundness
Investors, especially the foreign ones, deliberately pursue nations which are economically strong and politically stable. A country with striking economic performance and political firmness will attract more investments unlike nations that exhibit economic and political perils.
Nations with consistently lower inflation indicates a nation’s currency value rises since its purchasing power escalates relatively to other currencies. Conversely, those with higher inflation notice their currency value declining in relation to other currencies, which is usually followed by greater interest rates.
Higher inflation rate is tantamount to higher interest rates. Central banks decide on rates. Therefore, when they manipulate rates, they affect currency values and inflation. Exchange rates, inflation, and interest rates are correlated. Raising rates draw more investments, which lead to higher exchange rates, and lowering rates dent prevailing exchange rates.
It is normal for a country to secure large-scale financing to sustain governmental funding and projects. But accumulating huge public debt loads push away foreign investors. Here’s why: large debt results in higher inflation. If inflation rate is high, a government may be forced to service its debts or print additional money to repay a huge chunk of its debt load. Defaulting on debt obligations is another red flag for traders.
Terms of Trade
If a nation’s export increases modestly, the exchange rate will slump in parallel to its trading partners. If a country’s export rises significantly, demand has surged and terms of trade have improved.
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