Why do currencies change

The economic and political conditions of a country can also cause a currency's value to fluctuate. While investors enjoy high interest rates, they also value the predictability of an investment. This is why currencies from politically stable and economically sound countries generally have higher demand, which, in turn, leads to higher exchange rates.

Markets continually monitor the current and expected future economic conditions of countries. In addition to money supply changes, interest rates, and inflation rates, other key economic indicators include gross domestic product, unemployment rate, housing starts, and trade balance a country's total exports less its total imports. If these indicators show a strong and growing economy, its currency will tend to appreciate as demand increases.

Similarly, strong political conditions impact currency values positively. If a country is in the midst of political unrest or global tensions, the currency becomes less attractive and demand falls. On the other hand, if a market sees the introduction of a new government that suggests stability or strong future economic growth, a currency may appreciate as people buy it based on the good news.

There is no single indicator that explains exactly why a currency has fluctuated or predicts with certainty what its price will do. Instead, many factors related to demand and supply affect currency values. Related to all of the above is one overarching factor: stability. The market loves it and is constantly monitoring economic indicators and current events to find where it exists and where it may be lacking.

However, if the country is going through a period of political upheaval, these economic factors pale into insignificance. This discourages foreign investment and often leads to a decrease in demand for the currency and its value drops across the globe: for example, uncertainty over the repercussions of the Brexit vote led to a freefall in the value of sterling.

So when it comes to maintaining the value of a currency in the long term, confidence and stability are the watchwords. And in the short term? Azimo Blog. Why do foreign exchange rates fluctuate? How do interest rates affect currency fluctuation? First, devaluation makes the country's exports relatively less expensive for foreigners. Second, the devaluation makes foreign products relatively more expensive for domestic consumers, thus discouraging imports.

This may help to increase the country's exports and decrease imports, and may therefore help to reduce the current account deficit. There are other policy issues that might lead a country to change its fixed exchange rate.

For example, rather than implementing unpopular fiscal spending policies, a government might try to use devaluation to boost aggregate demand in the economy in an effort to fight unemployment. Revaluation, which makes a currency more expensive, might be undertaken in an effort to reduce a current account surplus, where exports exceed imports, or to attempt to contain inflationary pressures. Effects of Devaluation A significant danger is that by increasing the price of imports and stimulating greater demand for domestic products, devaluation can aggravate inflation.

If this happens, the government may have to raise interest rates to control inflation, but at the cost of slower economic growth. Another risk of devaluation is psychological. To the extent that devaluation is viewed as a sign of economic weakness, the creditworthiness of the nation may be jeopardized.

Foreign investors will sell their bonds in the open market if the market predicts government debt within a certain country. As a result, a decrease in the value of its exchange rate will follow. Related to current accounts and balance of payments, the terms of trade is the ratio of export prices to import prices.

A country's terms of trade improves if its exports prices rise at a greater rate than its imports prices. This results in higher revenue, which causes a higher demand for the country's currency and an increase in its currency's value. This results in an appreciation of exchange rate. A country's political state and economic performance can affect its currency strength.

A country with less risk for political turmoil is more attractive to foreign investors, as a result, drawing investment away from other countries with more political and economic stability. Increase in foreign capital, in turn, leads to an appreciation in the value of its domestic currency. A country with sound financial and trade policy does not give any room for uncertainty in value of its currency.

But, a country prone to political confusions may see a depreciation in exchange rates. When a country experiences a recession, its interest rates are likely to fall, decreasing its chances to acquire foreign capital.