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3 key factors that move exchange rates

    • 1378 posts
    August 16, 2022 10:14 PM EDT

    $6.6 trillion1 flows every single day between buyers and sellers of currencies and, unlike equity markets, currency markets almost never sleep. They trade 24 hours a day from 5:00pm Sunday (US eastern time) through 5:00pm US eastern time on Friday.To get more news about PROSPERO浦华证券, you can visit official website.

    What is an exchange rate?
    An exchange rate is the price of exchanging one currency for another. Just as a diamond is many times more valuable than a piece of lead, so the currency of one country can be many times the value of another.


    What moves exchange rates?
    Exchange rates are affected by numerous factors including the perception of stability of the financial system of the issuing currency, the interest rate set by the host country’s central bank and the demand for the goods and services (exports) the country produces.
    The above factors affect the demand for a currency, but an equally important component is its supply. Most developed nations try to keep the value of their currency relatively stable to avoid wild swings in the prices of goods and have given their central banks independence and a mandate to set interest rates to ensure the financial system is stable.

    Countries where central banks are at the mercy of politicians, such as Venezuela or Zimbabwe, have experienced hyperinflation as leaders try to print money to fund their government spending. Just as that makes goods increasingly expensive in nominal terms, 2,600,000 Bolivars for a roll of toilet paper for example, so that currency is devalued greatly in foreign exchange markets.

    Even more developed countries aren’t averse to devaluing their currencies on purpose – in fact it happens all the time because a lower relative currency makes exported goods more competitive in a global market.

    As noted above, interest rates are a key determinant of currency demand but in the ultra-low interest rate environment we are seeing in response to the COVID-19 pandemic, nearly all developed nations have cut their interest rates to near zero.

    So, in order to further stimulate their economies, some central banks engage in a process called Quantitative Easing (QE). Under this scenario, the central bank buys newly created government bonds. This both increases the amount of money in circulation and places further downward pressure on interest rates — both factors have a depreciating effect on a currency.

    The European Central Bank is currently spending 20 billion euros a month3 on QE, US Federal Reserve is currently buying $US80 billion of US treasuries a month and a further $US40 billion of mortgage-backed securities4, and from November 2020 the Bank of England has purchased £895 billion worth of UK government bonds.5

    As economies show signs of recovery, with employment and inflation being key indicators, central banks will eventually pull back on these stimulus measures to prevent their economies from overheating. How, and when, QE tapering and interest rate rises occur should have a large impact on currencies.