Currency exchange rates are prone to fluctuations, and there are times when some currencies fall way beyond expectations. For a recent example, you have to look no further than what’s happening to Venezuela’s currency, and history shows us that currency debasement was one of the main reasons for the fall of Ancient Rome.

Currency exchange rates remain a key indicator of the financial health of any nation and there is no dearth of resources spent in analyzing this realm. Exchange rate fluctuations affect governments, investors, and even individuals who simply want to send money overseas. What, then, are the factors that influence currency rate fluctuations?

Supply and Demand

As with every other market, the supply and demand principal is no different when it comes to currency exchange rates. If there is an excessive supply of a particular currency, there is a drop in its demand, and therefore, its value. On the other hand, if there is disproportionate demand for a currency, its value will rise. For example, a greater demand for American goods will result in the dollar’s appreciation. Conversely, if there is concern about the American economy, global markets will sell U.S. dollars, resulting in a fall in its value.

Speculation

A fall in a currency’s price can come about because of changes in commodity prices or political events. Speculation can lead to fluctuations in exchange rates especially if a momentum triggers particular interest in a currency. For example, if there is speculation that the euro will fall, people holding onto the currency would want to sell it for a currency that they feel will appreciate in value.

Inflation

Inflation refers to the rate at which prices of everyday goods and services rise. If inflation in the U.S. is lower than most other countries, the purchasing power of the U.S. dollar increases when compared to other currencies. In such a scenario, exports will become more competitive, and there will be a rise in demand for U.S. dollars that can be used to buy American goods. Countries with typically low inflation rates tend to witness appreciation in value of their currencies.

Interest Rates

Central banks have the powers to manipulate interest rates, and when they do this it affects exchange rates, among other aspects. If the U.S. makes its interest rates more competitive than other countries, it will attract more foreign capital. This will result in an increased demand for the U.S. dollars and cause its exchange rate to rise. A cut in interest rates, on the other hand, may lead to depreciation in the value of a currency.

Trade Balance

When the imports of a country exceed its exports, it has a trade deficit. When it is selling more than it is buying, it experiences a trade surplus. This affects exchange rates of currencies because when a country is under a trade deficit it requires additional foreign funding. This not only creates a demand for other currencies, but also results in a surplus of local currency. When countries face trade deficits, their currencies usually lose ground.

Government Debt

Countries get credit ratings from agencies such as Standard & Poor’s and Moody’s. These ratings depend on the possibility of defaulting on public debts, and they can affect currency exchange rates. If there is speculation of a default, it may lead to sale of bonds in a given currency, resulting in a drop in value.

Government Intervention

Governments, at times, take measures to influence their currencies’ value. China, for example, has tried to keep the yuan undervalued so that the country’s exports remain competitive. The country has achieved this by buying U.S dollar assets, thereby increasing the value of the dollar to the yuan.

Conclusion

While various factors affect exchange rates, keeping an eye on the market and your ears open may bring with it the insight you need to survive in this volatile field. If your requirement is no more than to transfer funds across borders, you may want to compare international money transfer companies that provide hedging options such as forward contracts and market orders. These tools give you the ability to make the most of exchange rate fluctuations.