Just like commodities, currency exchange prices are also influenced by the forces of demand and supply. These forces are triggered by several aspects, which cause increase or decrease of demand or supply suddenly, thereby causing the fluctuation of currency values.
Anything that significantly influences money flow between countries or within a country can impact the currency prices. Here are several aspects that typically influence the forex market:
A country’s economy status typically determines its currency value. Developing a strong economy is the foundation of a stable currency value which is highly trusted. Factors that affect economic growth positively or negatively can cause a disturbance in currency rates. For example, currency value falls during inflationary times — thus, the purchasing power of that currency decreases.
Before making forex trade decisions many economic indicators should be considered. The following indicators are representatives of several economic aspects:
- Gross Domestic Product (GDP). This is a quantitative measure of national economic activity. Steady GDP indicates healthy economic growth, and currency values generally rise under such conditions.
- Purchasing power parity (PPP). This measures the currency’s proportionate power to buy goods and services. For example, if 50 currency units from Country A is equal to 5 currency units from Country B, that means goods bought for 50 units in Country A country must be equal to the same goods bought for 5 units in Country B. If the countries PPP do not match evenly, then the country with greater purchasing power will hold a higher value in Forex trade.
- Interest rate parity. Interest rates in both countries must be comparable, so investments yield the same returns.
- Employment Status. National productivity is determined by employment levels. High employment suggests a healthy economy; that enhances currency value.
- Consumer spending. When spending is high, it generally means people are confident about their future investment yields and earnings. This usually results in a stable currency with high rates.
Of course, capitalist government policies are intended to encourage favorable economic conditions. When a national economy lags, governments usually try to correct the imbalances in one of two ways:
- Fiscal policies. Outlines Government spending for e.g. Annual budget
- Monetary policies. Central bank implements Government policies that enhance or sustain the economy through various investment strategies.
You can learn more about central bank influence on the forex market by reading the daily forexnews on the Internet.
Natural disasters like floods, or famine in a country negatively affect currency values. Under adverse circumstances, the money flow within that country’s boundaries gets severely restricted. People start becoming more cautious about spending, which dramatically reduces overall investment funds. Government spending gets reduced due to the huge expense in relief activities.
International trade activity reflects demand for a national currency because the exchange of money between countries influences the currency values of both nations. As a result, forex traders need to consider this aspect before making any investment decision.
Political unrest signals uncertainty about the future, and restricts economic growth. A war or upcoming election often results in a more careful investment approach, thereby decreasing a nation’s capital flow. Needless to say, politically unstable countries are not preferential trading partners.
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