Currency Trading – Things That Could Affect Exchange Rate

Currency trading isn’t just for investors who watch every major or minor currency with a view to buying and selling several times a week. In fact the largest group of people needing this service are individuals or businesses who trade or live in multiple jurisdictions, and need to make payments using another country’s money.

The rate quoted when buying or selling forex isn’t just set by the financial markets and supply and demand for a particular currency, often the reasons the dollar, Euro, Yen etc are in demand will be due to economic indicators that suggest investing in property, bonds, sharemarket, or products from a particular nation will be profitable, and this naturally drives up demand for the legal tender of the country in which the investment needs to be paid for.

Major monies such as the US dollar, Euro, or Chinese Yuan are always in demand, and often operate as de facto global currencies, so the strength of their issuing nations’ economy may not be a primary factor as why their rates fluctuate, instead it could be as simple as another currency faces pressure and investors rush to convert the money to more stable issues.

Interest rates from central banks play a huge role in stabilizing a currency against inflation or deflation, and often serve to protect the value of the money in the floating market, but in many cases this also adds fuel to the fire as high interest rates which are intended to reduce inflation also increase demand for the currency by forex specialists and speculators.

Of course the opposite is also true, lowering central bank interest rates is intended to stimulate economic activity and avoid deflation, yet has the impact of weakening the currency and causing investors to find other money to invest in. This rule isn’t a hard and fast rule, and in the vast majority of instances inflation and deflation aren’t terribly pronounced, so central bank activity is more about fine tuning economic activity.

A country’s trade balance with other nations or trading blocs will also significantly impact on their rate of exchange vis a vis other currencies, the stronger their exports, the more demand there will be for their currency, and similarly, the weaker a nation’s exports, or the more that they import relative to exports, the less investors or speculators will need of their currency.

The obvious exception to this rule might be considered the Euro relative to individual Eurozone members, many of whom do not have a strong export sector yet major export Eurozone economies such as Germany or France dominate demand and supply for the Euro. However, since most buyers and sellers of the Euro are more interested in its value against other major currencies, this is of little importance to them; the overall value of the Euro is more important.