Five major factors that determine foreign exchange rates

Winner Ajibola


What are Exchange Rates?

Put simply, a foreign exchange rate is a unit of measurement that weighs how much you can convert one currency to another. However, it goes beyond that. 

If your country’s currency is significantly lower when measured to its counterparts, that might mean that your economy isn’t exactly stable. Because when you convert it to other currencies, it will be worth a lot less. 

This is why every nation worries about the changing markets and how it affects their currency. While the exchange rate might fluctuate often, it shouldn’t go beyond a particular threshold. Else, it can create an impact on the value of the economy. 

Why are Exchange Rates Different Between Countries?

If you make enough foreign transactions, you’d know that currencies vary in their foreign exchange. Some are more valuable than others, especially the Dollar, Euro and British Pound. Here’s why this is so;

1. Inflation rates

Perhaps this is the most crucial factor. Inflation is what happens when the prices of goods and services go up. Generally, this means that the number of things your money can buy will also reduce. 

So when a country experiences a high inflation rate, its currency also reduces in value. When you compare that currency to other countries with low inflation, there’d be a significant difference in the exchange rate. 

It also applies when the tables are turned. If your country has a low inflation rate, the value of your currency will go up. This is a factor that often affects the exchange rate of most countries.

2. Country’s Debt

Another important factor is a nation’s debt. It’s natural for countries to owe. However, the amount can determine whether the country is heading towards inflation. 

So when a country has too much debt, foreign investors will sell their bonds, and the government will have lesser access to foreign capital. This is what often leads to inflation.

When these foreign investors sell their bonds, more money will be circulated, reducing its value.

3. Exportation and trade

Most countries carry out international trade, either importing or exporting items. However, the terms of these international trades can significantly impact the exchange rates. 

If your country has the upper hand in the pricing agreement, it means more revenue. So when they have this trade, the exchange rates will increase in your currency’s favour. 

Another great signal is when your export prices are higher than your import prices. Collectively this generates more demand for the currency. The higher the demand, the more value it gets. 

However, if your country keeps buying more than what it sells, you’ll need more foreign capital over time. So the local currency will get less demand which automatically translates to a lower value when compared with foreign currencies. 

4. Political stability

Oftentimes, the reasons aren’t all economic. Political factors can also influence exchange rates, and one of the major examples are political stability.

If a country is experiencing war or political unrest, other countries will be less likely to do business with them. As such, investors will no longer be attracted, making the local currency lose its value. This means the exchange rate will immediately depreciate. 

If the country hasn’t experienced political unrest in a long time and the likelihood of that happening is slim, then it will be more attractive for business. This can in turn, affect the exchange rate positively. 

5. Market predictions

Key stakeholders like to mitigate risks as much as possible, so they tend to predict the exchange rates based on external and internal factors. However, what happens is that these speculations directly affect the exchange rate. 

So, for example, if an investment bank or wall street predicts that a particular currency’s value will increase, there will be an automatic increase in demand for that currency. Once there’s more demand, there’ll be a favourable exchange rate and vice versa. 

How Can I Get the Best Exchange Rates? 

Well, irrespective of what the market says, you can still get the best exchange rates and save money during your international transactions. 

For starters, you always want to stay on top of the market. This way you can create a trend as to when the rates are likely to improve and when they’d be dipping. 

We discussed this a lot more extensively here, along with four other tips on how to always get the best exchange rates. 

Wrapping up

Foreign exchange rates are always going to fluctuate. What matters is that you understand why and turn them around in your favour. 

If you’re a traveller going to a new country soon or just looking to swap funds for a specific need, we recommend using Grey.

With a Grey account, you can receive, send and swap your foreign funds at the best exchange rates. Sign up for a free foreign bank account here.

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