Economics explained
Category:
Exchange rates
Demand and supply of the currency
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Demand comes from individuals, firms and governments who want to buy a currency and supply comes from those who want to sell it.
Supply and demand are subject to a number of influences:
The rate of inflation, compared with the rate of inflation in other countries
An increase in the price of goods and services caused by domestic inflation will tend to decrease the demand for exports. This will therefore tend to cause the exchange rate to full in value.
The balance of payments
An increase in the demand for exports will increase the demand for the country's currency. Therefore this increases the exchange rate. An increase in the demand for imports, will raise the value of the foreign currency in order to facilitate the purchase of foreign goods and services.
Government policy on intervention to influence the exchange rate
With a freely floating exchange rate there can be no overall balance of payments disequilibrium. Foreign exchange dealers will constantly adjust the exchange rate to balance their books, so that the demand for and supply of any currency are equal.
Interest rates, compared with interest rates in other countries
Higher interest rates in a country increase the value of that country's currency relative to nations offering lower interest rates.
Speculation
Currency speculation is the act of purchasing and holding foreign currency in the hopes of selling that currency at an appreciated, or higher, rate in future.