Apart from specific factors such as inflation and interest rates, the currency exchange rates may be among the most significant determinants of a nation’s economic health. The relative rate of trade is also determined by the exchange rates, which are very key to the free market economy globally. For these reasons, exchange rates have become one of the most analyzed and watched measures by the government.
Nonetheless, the exchange rate also matters on a smaller scale since it affects a stockholder’s portfolio returns. There are excellent companies like currency exchange Calgary who have various experts who can help you manage global payments and foreign currency exchange and develop solutions to help minimize risk and returns.
Some of the major factors that affect exchange rates include:
1. Difference in Inflation
A nation with a consistent inflation rate that is too low tends to exhibit a higher currency value, since the purchasing power always increases compared to other currencies. In the previous year, most countries with a low inflation rate included Switzerland, Germany, and Japan, and later Canada and the U.S joined.
Countries with high inflation rates basically see their currency depreciating while trading with their partners. High inflation rates also lead to high interest rates.
2. Terms of Trade
Terms of trade is a ratio that relates between export prices and import prices. It is associated with the balance of payment and current accounts. When the price of exporting commodities rises in a country at a higher rate than the importing prices, it results in trade improvement. When the terms of trade increase, a country may show more demand for its exports.
If the terms of trade go high, the revenue of a country’s exports may also increase, providing the country with more demand for its currency, hence increasing the currency’s value. When the export prices increase by a smaller rate than the import prices, the country’s currency value will depreciate with its trading partners.
3. Public Debt
Nations engage in deficit financing to help in paying for government funding and public sector projects. Public debts may influence the domestic economies, and nations with large public debts become unattractive to foreign investments. Debts encourage the rate of inflation to rise.
Most public debts are always paid in the future, though a nation may print money to pay huge debts in some scenarios. However, when the supply of money increases, it affects inflation, hence lowering prices. Foreigners will not be willing to invest in a country with large debts. Debts are essential in determining the exchange rates.
4. The difference in Interest Rates
Exchange rates are highly related to interest rates. When interest rates are manipulated, banks exert pressure on exchange rates and inflation. If interest rates change, they affect the currency values.
When interest rates rise, it leads to a higher return on a nation’s economy and also attracts foreign investors, since the currency rates go up, but when the interest rates decrease, it results in low exchange rates and fewer investors.
Other factors that can affect currency exchange rates include:
- Current accounts deficit
- High economic performance
If the exchange rates decrease, the purchasing power goes down in terms of capital gains obtained from returns, and income rates also decrease. The exchange rates also affect interest rates, capital gains from local securities, and inflation. Make sure you understand how currency exchange rates operate, especially if you are an investor.