Factors Affecting Forex Exchange Rates
Banks are primary players of the foreign exchange market which is why the latter was also called an interbank market especially when it dealt with banks. Central banks such as the Federal Reserve Bank of the United States, investment banks like Goldman Sachs and commercial banks are active players of the forex market. At present, there are many other players aside from banks that participate in this market. Because of the large size of the market, no single company can influence how it operates. Several factors influence forex exchange rates and these are categorized into three namely: economic factors, political conditions and market psychology.
Among the economic factors that can affect forex exchange rates including economic policies of countries regulated by certain government agencies and central banks, and economic conditions based on economic reports and other indicators. The economic policy of a country includes its fiscal and monetary policies. The former includes the budget and spending practices of a country and the latter refers to the action taken by the central bank of a government to influence the cost and supply of money. Examples of government conditions are government budgets or surpluses, balance of trade levels and trends, inflation levels and trends, and economic growth. Budget deficits impact an economy negatively while narrowing budget deficits affect an economy positively. Balance of trade levels and trends reflect the ability of a country to conduct trade relations with other countries. Inflation levels also affect foreign currency exchange rates because it can affect the purchasing power of people. Lastly, economic growth as measured through gross domestic product (GDP), employment levels, retail sales and other economic indicators, influence the currency of that country to perform better.
Furthermore, political conditions also affect forex exchange rates. Upheavals and political instability negatively affects the economy of a country, which also affects its currency. Election turmoil, transition in governments, and international conflict also make investors wary about investing their money in a particular country. Political conditions may also positively or negatively affect neighboring countries belonging to the same region. The last category of factors that affect forex exchange rates is market psychology. This includes the perceptions of traders about the forex market including long-term trends and the concept of "flights to quality" which describes how investors tend to demand for currencies that are thought to be stronger than other currencies. An individual investor cannot influence forex exchange rates but the collective actions of all traders, investment funds and banks can influence such. The collective selling of a particular currency can decrease its price and increase its supply. In the same way, if investors collectively speculate that a certain currency will appreciate soon, they will collectively buy that currency, increasing forex exchange rates and influencing its price to go up.
In addition, a variety of foreign exchange participants affect the demand and supply of currencies. These are export and import companies, foreign investors and banks, market speculators and central banks that regulate prevailing interest rates. Aside from facilitating commercial transactions, converting profits and hedging against future price drops, more and more participants have also joined the forex market for the purpose of speculation.
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