This article covers the fundamental factors that could have an effect on a country’s foreign exchange rates.
When you wish to determine the potential foreign exchange rates of your currency pair, you can make use of fundamental analysis. This involves consideration of a range of political and economic factors related to the currencies in question. Fundamental analysts review as many of these factors as possible on a regular basis. This is done for each currency they are interested in and they will compare it relevant to another currency to determine foreign exchange rates.
When new economic information enters the foreign exchange market suddenly, it often prompts undue market movements and volatility. This occurs as traders react to the news. At these times, the ‘price discounts all’ analogy linked to technical analysis falls by the wayside until new information has been gathered. If you are a technical trader, you should be aware of the effect of news announcements on the market as it can bring about unexpected results on your technical based trades.
Some of the fundamental factors that may affect a country’s currency exchange rate include:
Short term interest rates have a direct effect on currency rates. Countries with higher interest rates attract foreign investment which increases the demand for the particular currency. This demand increases the value of the currency.
The economic outlook for a country can affect its foreign exchange rates. Peaceful countries with stable political climates and growing economies are more favoured than less stable countries.
Gross domestic product is an important factor as it measures the economic growth within a country. A growing economy tends to strengthen the country’s currency value.
The current account balance of a country is important since a current account deficit will deter investment. This will decrease the value of the country’s currency.
Foreign Exchange Rates and Economic Factors
Forex traders generally maintain a forex calendar related to their currency pairs. This is an important tool since the release of important news announcements and data can have a dramatic impact on the market.
The rate of inflation is an important factor to consider. A rising inflation rate could prompt a country’s central bank to increase interest rates to curb the rise in the inflation rate. This increase often causes an increase in the currency rate as investors are drawn to countries with higher interest rates. This method of curbing the inflation rate has other more detailed implications from the central bank’s point of view.
- Interest Rates
An increase in interest rates could push the country’s currency rate up. This will increase the demand for the currency as investors will move their funds from countries offering lower interest rates.
A country with huge loans from other nations or the International Monetary Fund will not be attractive to investors as it would appear to be unstable economically. This will decrease the value of its currency rate.
- Commodity Prices
Commodity prices can have an effect on a country’s exchange rate, particularly if that country is very dependent on its commodities. The forex rates of these countries are often directly linked to that of the commodity prices.
There are many fundamental factors that affect the foreign exchange rates of countries. It is advisable for you to keep up to date on these as it will give you the opportunity to predict the rates and improve your trading.