In the forex market, numerous factors can affect the movement of a currency. To become a leading trader, you need to use analysis to make informed trading choices for your currency pairs. This includes observing different factors that affect the valuation of different currencies.
Here are factors that influence the movement of currencies in forex.
Inflation
The inflation conditions in a country significantly affect the value of a currency and, consequently, the change rates in a country. Countries with lower inflation rates experience an appreciation in the value of their currency since it has increased purchasing power.
For instance, if the inflation rate in the Eurozone is lower than inflation in the US, exports in the United States are less competitive than in the Eurozone. This increases the demand for euros currency to buy goods in euro countries. This increased demand for a currency caused appreciation.
The interest rate
Interest rates is highly related to inflation and the exchange rates. Central banks can manipulate interest rates to influence inflation, which affects the value of a currency. When high-interest rates are imposed, investors get higher returns compared to other counties. This increases the value of the higher-yield currency.
If a country’s inflation is higher than in others, the impact of high-interest rates is controlled. This can also happen when other factors are causing the depreciation of the currency.
Public debt
As a way of stimulating the economy, some countries borrow capital for public sector projects. Countries with significant public deficits are not attractive to foreign investors since too much debt causes inflation, which causes depreciation in the currency. This is why investors take into account a country’s debt to determine their choice of trading currencies since it affects the exchange rate of a currency.
Deficits in current accounts
A current account is a part of the balance of payments used to record a country’s transaction with the world over a given period, especially in goods and services net trade, net earnings on cross-border investments and net payments.
The current-account deficit shows that a country imports more than it exports. This means that it has to borrow capital from other sources to make up for lack of capital. This causes the currency of a country to depreciate compared to its trading partners and increases the demand for a foreign currency that is more stable and of higher value.
An increase in demand for a foreign currency causes the local currency to depreciate until local goods and services become competitive with imported goods and services. This stimulates the demand for local products, therefore boosting the currency.
Political stability
Foreign investors are always looking for politically stable countries to invest their capital. Any event that causes instability politically causes investors to lose confidence in the country. This causes them to reconsider investing in an unstable country, causing capital flight, which has severe consequences for the currency.
Market sentiments
Sometimes exchange rates movements can be driven by market speculation. Traders often invest in currencies they believe may increase in value in the near future. This increases the demand of the currency, which drives up its value.
The strength of other currencies
In 2010 and 2011, forex markets became concerned about the global economy’s health, especially in the USA and Europe. This made the Swiss Franc and Japanese Yen safe currency havens for investors. While interests were low in Switzerland and Japan, the currencies appreciated in value because of this growing demand.
Government intervention
To gain value against competing currencies, some countries work to influence the value of their local currency. For instance, China’s financial system has gone the extra mile to devalue the yuan against the dollar as a way of favoring its exports. They do this by investing in assets dominated in dollars to increase the value of the dollar against its own currency.
Conclusion
All factors mentioned above impact the forex market. As a forex trader, it is important to remain updated on these factors to make informed trading decisions based on the information you gather on the types of currencies you trade. With this information, you are better placed to decide on the best currency pairs to trade or the best buy/sell position for your currency pairs.