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Economics explained


Exchange rates

Factors changing foreign exchange rates

Factors changing foreign exchange rates

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Changes in the demand for and supply of a currency will cause a change in the price of the currency in the case of a floating exchange rate and will put upward or downward pressure on a fixed exchange rate.

Demand for the currency will rise if a higher value of exports is being sold.

Foreigners may buy more of the currency in order to open accounts in the country’s banks because of higher interest rates.

Foreign firms may purchase a greater value of the currency in order to set up branches in the country, perhaps because of a rise in labour productivity in the country.

Speculation may account for a large proportion of the currency purchased.

If it is thought that the value of the currency will rise, people may buy the currency in the hope of making a profit.

The value of a fixed or managed floating exchange rate may be changed by the pressure of market forces.

For example, a government may decide that the currency is undervalued because it keeps having to sell the currency to maintain its value. In this case, it may decide to revalue the currency.

A government may also decide to alter a fixed exchange rate or influence an exchange rate within a managed float in order to achieve a macroeconomic aim.

For instance, a government may devalue its currency, possibly below its long-run equilibrium level, in order to gain a competitive advantage and improve its current account position.

Alternatively, a government may set a high exchange rate to reduce inflationary pressure.

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