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What affects the foreign currency exchange rate?
The foreign currency exchange rate can be influenced by several different factors that affect a country’s economy including the interest rate, strength of the country’s economy, political climate and more. As a result, the foreign currency exchange rate fluctuates on a daily basis, and some countries can experience dramatic fluctuations, especially if they are in a period of political and economic instability. Countries that have more of a stable climate will experience less fluctuations in their foreign currency exchange rate. If you are looking to buy foreign currency, you should try to time your purchase to when the foreign currency exchange rate is the most favorable, and if you know a little bit about the factors that influence it, you may be able to save money on your currency purchase.
The political stability of a country influences its exchange rate
The political stability of a country is one of the biggest factors that influence its exchange rate. In general, countries that may be going through a political upheaval or any type of political instability may have a weak foreign currency exchange rate compared to other countries, because those countries may be seen as risky for foreign investors. The countries with the strongest foreign currency exchange rates typically have a more stable internal political climate, and their governments have usually been established for many years. Any time a country is going through a period of political turmoil or internal conflict, its foreign currency exchange rate can be negatively affected.
The current account deficits of a country influence its foreign currency exchange rate
Account deficits, or a negative balance of trade between one country and another, can negatively influence a country’s foreign currency exchange rate. The current account represents the trade balance including the payments between countries for goods and services, dividends and interest. If one country has a deficit with a trading partner, it means that the country owes its trading partner, and that it is spending more than it is earning with that particular country. If a country has a deficit, it will need to borrow money from other sources to compensate for that deficit, and because of that, the foreign currency exchange rate can be weakened.
A country’s terms of trade influence the foreign currency exchange rate
The terms of trade, or the ratio that compares import prices to export prices, is a very important factor that influences the foreign currency exchange rate. A favorable terms of trade shows that a country’s exports have increased at a faster rate than its imports, showing that the country is productive and that its goods are in high demand. The increase revenues from the country’s exports strengthen its economy and as a result there is a higher demand for that particular country’s currency. The increased demand will usually strengthen the country’s currency, and its foreign currency exchange rate will start to improve (more foreign currency will be able to be purchased for the same amount of domestic currency). There are many other economic factors that influence exchange rates, but these are some of the most prevalent factors.