Factors Affecting Forex Rates

Factors Affecting Forex Rates

Submitted by adil on Fri, 01/06/2012 - 08:01

Forex trading online is not only influenced by the techniques adopted by the traders. There are other factors that affect Forex rates. There are many factors that influence currency values in any country. We will discuss only three in this article.

Relative Inflation Rates:

The inflation causes the weakening of nation�s currency. A nation running a relatively high rate of inflation will discover its currency declining in value relative to the currencies of nations with lower inflation rates. If the supply of a currency increases relative to its demand, the economic climate will trigger inflation. For example, greater prices in the United States will lead American consumers to substitute European imports for U.S. goods, resulting in an increase in the demand for euros. Hence a greater rate of inflation within the United States than in Europe will simultaneously increase European exports to United States and reduce U.S. exports to Europe. In other words a greater rate of inflation within the United States than in Europe will lead to decline in the dollar relative to euro or to a rise in the euro relative towards the dollar.

Relative Interest rates:

Rate of interest differentials will also impact the equilibrium exchange rate. For example, a rise in US interest rates relative to European rates all else being equal, will trigger investors in both nations to switch from Euros to dollar. This will result in depreciation in the Euro in the absence of government intervention. The discussion is about real interest rates. The actual interest rate equals the nominal or actual rate of interest minus the rate of inflation. The distinction in between nominal and real interest rates is critical in international finance. If the improve in U.S. rates relative to Euro rates just reflects greater U.S. inflation, the predicted result will probably be a weaker dollar. Only an increase in the real U.S. rate relative to the real Euro rate will result in an appreciation in dollar. 

Balance of Payments:

Balance of payments represents the demand and supply of foreign exchange which ultimately determine the value of the currency. When the balance of payments of a country is continuously deficit, it implies that the demand for the currency in the country is lesser than its supply. Therefore, its value in the marketplace declines. If the balance of payments is surplus continuously, it shows that the demand for the currency within the exchange marketplace is greater than its supply and consequently the currency gains value. Join Intellitraders for free trading online tutorials and experts help.