6 Factors That Could Affect Exchange Rates

Though they may not have significant importance to your own life, exchange rates will impact a country’s economy, international businesses, and travelers who wish to exchange their money into a different currency.

It could also have an effect on those people who need to send money abroad, although, with the help of a comparison site that provides the best value international money transfers, this process can be made easier.

To some people, it is common knowledge that certain factors can affect exchange rates. More often than not, these factors will affect global currencies instead of local ones.

That being said, now is a good time to learn more about what these factors are.

1. Economic Health

One factor that has the ability to influence an exchange rate is the overall health of an economy. In simpler terms, this will be their performance levels.

If you live in a country that has a strong economy, you will find that it is much easier to attract foreign investments than those who live somewhere where the economy is much less robust.

A country that has a strong economy will soon see lower levels of inflation which, in turn, will significantly increase the exchange rate of the country’s currency.

The health of the economy will also include interest rates, inflation, and balance of trade.

2. Inflation

Following on nicely, inflation will also have an influence on the exchange rates.

In short, it is the relative purchasing power of a currency compared to other currencies. What may cost a country little when it comes to buying a certain item, may cost another country a lot more to buy the same thing.

If your country has higher inflation, you could be expected to pay more. In turn, this is why countries have different currency rates.

Stronger currencies are linked to those countries that have low inflation rates.

3. Public Debt

In order to establish economic growth, many countries go down the route of large-scale deficit financing. What this means is that they borrow money to establish such growth.

If this debt grows quicker than the economic growth that they achieve, the chances of this driving up inflation by preventing foreign investment from entering the country are very likely.

On the other hand, a country’s government may print money to finance this debt. This will also increase inflation.

4. Interest Rates

Like inflation, interest rates also have a close connection with exchange rates. To be able to control and manage inflation, central banks of these different areas will use interest rates to get the best deal.

As we’ve already said, if a country has been able to successfully higher its interest rates, it will attract foreign investments that will ultimately improve the local currency rates.

A disadvantage of this is that if these rates remain too high for a long period of time, inflation will start to increase, therefore resulting in a currency that has been devalued. This is why central banks need to adjust rates to balance both advantages and disadvantages.

5. Balance of Trade

If you have never heard of the term balance of trade before, all you need to know is that it is the difference between the imports and exports of a country.

By hearing someone say that a country has a positive balance of trade, all it means is that exports have exceeded their import levels. In basic terms, the inflow of foreign currency is higher than the outflow.

Due to this, its foreign exchange reserves grow, thus lowering interest rates. This will then stimulate economic growth as well as bolstering the local currency exchange rate.

6. Stability of a Country’s Politics

A country that is politically stable will attract higher levels of foreign investment, which will help improve the currency rate. On the other end of the spectrum, a country that has poor political stability will see its exchange rate devalue.

The stability of a country’s politics will also affect the local economy and financial policies, which then have a long-term effect on a currency’s exchange rate.

Countries with great political stability, like Switzerland, will have a stronger and higher valued currency.

There are so many factors that can affect the exchange rates of a country. Having knowledge on some of these will help to put you in good stead when it comes to navigating this process further down the line if you must.