may affect forex rates, the most
serious include economic factors,
commodity prices and the terms of trade, interest rate differentials,
political factors and capital flows.
The influence of economic
factors on foreign exchange
Economic
circumstances can have a significant impact on long-term foreign exchange rate movements, and
the most significant factors are relative inflation rates, and the
balance of payment trends.
Relative inflation rates
The purchasing power
parity (PPP) exchange-rate calculation asserts that
international exchange rates should adjust to
equalise the price of a basket of products in a
common currency. So, a basket of products and
services in France ( including items
like food, property, utilities, entertainment, etc. ) should cost the same as a basket of the same services
and goods in the US, or Australia, or
Singapore, once the value of each basket has been converted to a common
currency.
However, if one
nations inflation is higher than another, sooner or later that nations exports
will be more expensive than similar products in the second
country. If we say the 1st country is the US, and the
second is Singapore, this would make it
desirable for the US to import more from Singapore,
as Singapore's products will be less expensive.
Accordingly, as products manufactured in
the States are getting more
expensive due to inflation, the US will export less and will run a
rising trade deficit with Singapore.
This could only be corrected by a depreciation in
the foreign-exchange rate.
Therefore if
the price of a basket of products and
services in Singapore rose by 3%
over the passage of time and the price
of the same basket rose by 15% in the US, the US
dollar should depreciate by 10.4% to fix the relative
inflation rates: (115 – 103)/120 x 100 = 10.4%
That having
been said, there are a number of problems with
the PPP measurement :
- Different nations don't use the same
baskets of products - The range and quality of these products
can change - Trade barriers, like transport costs and trade
restrictions, break the link between
the prices of products in different nations - Nations don't comply to a uniform
price level though food prices may be higher
in one country, that country might also have lower house prices - At its most elementary, PPP doesn't take into account relative
revenues, and also must be
altered for GDP
And, so far as
it's affect on the foreign exchange market is
concerned, currency is traded for reasons aside
from the exchange of services and
goods. Nonetheless PPP foreign-exchange rates can be helpful when
official rates re manipulated by governments, as it
is likely the most pragmatic foundation for
commercial comparison when a country appears artificially
strong.
Balance of payment trends
When foreign-exchange
rates were fixed (1944-1973), nations with persistent payment
deficits might devalue their currencies to encourage exports and
discourage imports.
In the
existing floating foreign exchange market,
the belief that currencies of countries in
debt with payment issues will deflate, while the
currencies of countries with trade surpluses will inflate,
has been carried forward.
The currencies of
countries with persistent trade deficiencies will
usually be pushed down as there are far more sellers of the
currency ( importers paying for goods in
foreign currencies ) than buyers of the currency ( exporters
who have to convert foreign invoices into local
currency ).
The impact of commodity
costs and the terms of trade
Commodity
costs can have a serious impact on
the foreign exchange rate movements of
commodity currencies (the currency of a land that relies heavily
on the exportation of commodities for
income), such as the AUD, CAD and NZD.
Quite
simply, when the demand for commodities goes up, so do their
costs, and so does the GDP of a major commodities exporter. So,
the value of the commodity producer’s currency also rises.
The terms of trade is a proportion comparing export
and import costs if a country's export costs rise
by a greater rate than its import costs, that
country's terms of trade have favorably improved. If a
country's terms of trade improve, the demand for exports
causes a rise in the currency's value.
The impact of interest rate
differentials on foreign exchange
Differentials in
interest rates are have one of the biggest impacts on
short term movements in foreign-exchange
rates. Higher interest rate currencies have a tendency to
appreciate against lower interest rate currencies, as
investment in securities carrying a higher
interest rate will result in greater returns
that investment in securities with a lower
interest rate. As it's important to buy the
pertinent currency before getting a
security, the demand for this currency pushes the foreign
exchange rate up.
However, this only works if
all other factors between the countries are
equal. If an economic
degradation is expected to
undermine a currency, the interest rate differentials would have
to be exceedingly giant to nullify
the acknowledged exchange rate risk.
This is why central banks may tighten financial policy to forestall downward pressure on currencies.
The
impact of politics on foreign exchange
Political factors may affect the foreign exchange rate in the
short term, as foreign investors withdraw money from a
country in periods of political doubt.
This means election campaigns can be turbulent times in
the foreign exchange market, as one party may be
campaigning for financially irresponsible policies, or policies that
are disagreeable to investors.
Government
interference into the market can also have an effect on foreign exchange rates.
The impact of capital flows on foreign
exchange
The flow of capital
into a country can have a major influence on a currency
rates, particularly if all the other factors are
relatively stable. When investor sentiment favors a
certain economy or industry, capital flows into that economy,
boosting the currency.
To
conclude
Although one can
explain forex rate movements in relation to the economy, politics, rates, etc., it is
simpler to evaluate this retrospectively than it is to prediction
currency exchange rates, as these
factors might be pointing in different directions. The forex trading of both
beginner and experienced traders can gain benefit from reading market analyses written by
forex brokers, who
might be more experienced at interpreting movements
presently taking place in the market.
Remember that CFDs and forex are geared products and may lead to losses that surpass your initial deposit. CFD trading might not be suitable for everyone, so please make sure that you understand completely the risks involved.
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