Foreign exchange pricing between currency pairs fluctuates daily and is driven by a number of factors including, market sentiment, economic data releases, interest rates and political stability. All of these factors ensure the market remains active and therefore exchange rates and pricing change by the second.
Monetary Policy – interest rates and QE
Many central banks actively lower or raise the interest rate of their country to heighten or decrease the demand for their currency. The weaker the currency the more attractive the price of their goods become to importers. They may also lower interest rates in conjunction with increasing the amounts of currency in circulation. Commonly known as quantitate easing or QE this weakens currency strength dramatically. Put simply the central bank prints more money therefore flooding the market and weakening the value of the currency.
Rate of inflation
Rates of inflation can give a great image of a country’s economy as it serves as an accurate barometer of the price of everyday goods and services. A slowly increasing rate of inflation indicates the economy is typically in a healthy state. However sharp increases usually cause economic instability. In this scenario central banks intervene by increasing interest rates, encouraging people to save rather than spend. This will in turn attract investment from overseas and increase the strength of the currency.
Global economic data
Economic data has a huge effect on pricing, for example if the UK GDP growth comes in higher than the markets expect traders will find this a hugely positive factor and therefore typically sterling exchange rates would strengthen. Data is released daily and gives an indication into the health or outlook of a certain sector. Typically market markers price in economic data however if the data surpasses or misses’ expectation markets can see a huge sell off or purchase which exasperates theses movements. Key data includes CPI – consumer price index, PMI – purchase managers index, retail sales figures and employment data to name a few.
How political scenarios
Political uncertainty or the run up to an election can have a huge effect on the country’s currency. An election is often viewed as an extremely uncertain by traders and market makers as there are typically regular swings of approval between opposing parties, different polls will also indicate different parties may or may not have the upper hand and this regularly causes exchange rate volatility. A change of government can also provoke a change of process and in turn a change of thought on economic scenarios such as monetary policy. Therefore, a party which is viewed as pro economic growth will be viewed favourably by markets and a currency theoretically should strengthen.
Natural disasters or acts of God
Following a natural disaster, the country effected can see huge amounts of money wiped off its markets. Often a significantly reduced work forces will have huge implications on the countries productivity and trade. Infrastructure will also be greatly affected meaning factories close, exporters have little to export and therefore exchange rates devalue and future GDP can suffer.
On occasion a governments debt levels can affect the desirability and strength of their currency. Particularly if that country’s predicament is likely to cause some sort of financial default.
Some central banks and governments actively drive down the price of the currency by investing heavily in foreign assets. This makes their goods attractive to importers.
Stagnant or under pressure economies can also request central banks peg their currency to another to ensure its rate and desirability boosting exports. Typically, this will be with the USD or EUR.
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