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The 8 Economic Factors that Dictate the Exchange Rates

The 8 Economic Factors that Dictate the Exchange Rates

The Forex market is a term that refers to the global marketplace where people from different countries trade in trillions of dollars of the world’s currencies every day. Since it covers such a wide area, this market is subject to a couple of factors.

 

Forex traders use these economic factors to determine how they will buy and/or sell currency to maximize gains.

 

1. The Current Account (deficit or surplus)

As part of the Balance of payments, the state of the current account of a country helps predict the value of its currency. The balance of payment encapsulates all international transactions in a country. The current account gauges the outflows and inflows of goods and services into a country.

 

When a country exports more than it imports, it results in a current account surplus, while higher imports than exports lead to a current account deficit. A current account deficit means that the people of the given country are buying more than they are selling and are therefore offloading their currency thus putting downward pressure on its value. A current account surplus, in turn, is indicative of a thriving currency. Most governments release reports of their balance of payments on a quarterly basis.

 

2. Terms of Trade

The terms of trade play an important role in the forex market and are linked to the aforementioned Balance of Payments. The levels of imports in relation to exports serve as an indicator of the demand for a given country’s goods and services. A country whose goods and services are in high demand witnesses an increase in the value of its currency. Buyers of these goods have to convert their money into the country’s currency increasing demand for this currency thus pushing its value. The reverse is true for a country whose goods and services are not performing well.

 

3. Political Factors

The politics of a given country dictate how its economic plans unravel. The perceived value of a currency is also affected by the political climate of the country. Forex traders monitor the political news to predict what a government’s economic policies will be.

 

Subsequently, major events like upcoming elections and political upheavals play a part in determining a currency’s value.

 

4. The Inflation Rate

The inflation rate is the rate at which the prices of goods and services are generally rising in any given economy. When the inflation rate in a country is high, the value of its currency drops. When the inflation rate is low, the currency becomes relatively more valuable.

 

5. The Interest Rate

The Central Bank of a country sets the interest rates as part of its monetary policy function. It can vary the interest rates based on the economic climate at a particular period of time. For example, if the inflation rate is higher than the desirable amounts, it can increase the interest rates to reign in on the amount of money in circulation. Consequently, the currency rate also increases and vice versa.

 

6. Employment Rates

Forex traders regularly check the employment statistics released by different countries because they serve as an indicator of the economic state of the countries in question. High unemployment rates are evident when economic growth stagnates or regresses. This means that the currency is also plummeting in relation to other world currencies.

 

7. Speculation

Speculation is intangible and immeasurable but still a very important factor in currency trading. When there is speculation that a certain currency will increase in value, its demand increases further boosting its value. When a trader uses an effective forex platform, they can use it to detect such changes and capitalize on the upward trend.

 

8. Public Debt

The national debt of any government tells whether a government is likely to secure foreign capital in the near or distant future. A country whose public debt is high makes foreign investors shy away from investing their money in it. As a result, the economic growth of the country slows down causing its exchange rate to fall.

 

Conclusion

These factors are influential in the Forex market and the best traders position themselves to anticipate movements and act accordingly. To have an edge in the market, traders should be keen on all the major economic and political events in a country as well as the long-term speculative moves made by big institutional investors.

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