There are a wide range of factors that influence foreign currency exchange rates, and we have discussed some of them on this blog. Foreign currency exchange rates are complicated and are influenced by many different factors as previously mentioned including interest rates, speculation, debt, economic instability, and more. All of these factors combine to influence foreign currency exchange, and the market can be quite volatile and rapidly changing. Getting familiar with the different influences on foreign currency exchange can help you determine when to buy a foreign currency and whether or not it is overvalued or undervalued based on these factors.

Deficits influence rates for foreign currency exchange

A country that currently has a deficit will have its foreign currency exchange rate impacted, usually negatively. A deficit shows that a country is importing more than it is exporting, and it is a sign of economic weakness. As a result there will be a lower demand for that country’s currency, and the country has to borrow foreign dollars in order to pay for its imports which increases demand for other country’s currencies. This is one of the major factors that influence the value of a foreign currency exchange, and many countries have had their currency values suffer due to running a consistent deficit over a period of years, but obviously there are many other factors involved.

Economic or political instability

Economic or political instability is one of the major factors that influence the value of foreign currency exchange; countries that are more politically unstable attract fewer investors because the environment is not conducive to business or economic progress. Economic stability shows that the country’s currency may not represent much in terms of purchasing power, especially if the country has a low gross domestic product and a low amount of experts.

Government intervention affects foreign currency exchange

Governments often intervene as a way to balance or tilt the value of a foreign currency into a more favorable direction. For example, the Chinese government has helped to close the “trade gap” with the United States by slowing the appreciation of the Yuan against the U.S. dollar through several interventions including buying U.S. dollars and purchasing U.S. treasury securities, as a way to keep surpluses of dollars out of exchange markets. Dollar surpluses would cause the Yuan to rise in value against the dollar, which is undesirable because China benefits from a strong dollar, and a weak dollar compared to the Yuan would lead to decreased imports from China.