It is useless to continue trading without knowing how and why exchange rates vary. In this article, we shall summarize some main factors that influence exchange rates and which will be very useful for understanding what happens in the real world and why prices move you trade in currencies. You might not need to know everything in detail like level forex traders (เทรดเดอร์ Forex ระดับs which is the term in Thai) but having an idea of what happens under your operations is necessary.
Numerous factors determine exchange rates, and they are all related to the commercial relationship between the two countries. Exchange rates are relative and are expressed as a comparison between the currencies of the two countries. These factors are not in any particular order: as with many aspects of economics, the relative importance of these factors is subject to much debate.
- Inflation Differentials
As a general rule, a country with a consistently lower inflation rate has a steadily strengthening currency, as well as its purchasing power increases relative to other currencies. Countries with higher inflation typically witness the depreciation of their currency relative to their trading partners’ currencies. This is usually followed by phases of raising interest rates to reduce inflation and rebalance exchange rates between currencies.
- Interest Rate Differentials
Interest, inflation, and exchange rates are all closely related. By manipulating interest rates, central banks exert an influence on inflation and currency exchange rates, and changing interest and inflation rates has an impact on currency values. Higher interest rates offer creditors a higher return than in other countries.
- Current Account Deficit
The existing account balances the current account balance between a country and its trading partners, which reflects all payments between countries for goods, services, interest, and dividends. A current account deficit informs us that the country is spending more than it can earn and borrowing capital from foreign sources to make up for the shortfall. In other words, the country needs more foreign currency than it receives through the sale of exports, and provides more of its currency than the foreign demand for its products.