What Factors Affect Currency Exchange Rates?

When transferring cash abroad, the exchange rate is the key cost element that reflects how much of a forgein currency you’ll get in exchange for your dollars. While multiple factors can cause exchange rates to fluctuate, the core driver is supply and demand.

Simply put, the more requirements there are for a currency, the more valuable it’s perceived to be on the foreign exchange market. Just like in any commodity market, more robust demand, or shortages in supply, means an increase in prices. Of course, global economics isn’t quite that simple, and numerous underlying factors might influence the demand and average exchange rate a currency receives on the Forex market.

Aside from Demand, What Else Causes Currency Exchange Rates to Change?

A country’s currency exchange rate often reflects the economic stability of the nation. For example, US Dollars, Euros, and British Sterling rarely fall outside of the top 10 most valuable currencies. Those nations (or blocs in the case of Euros) are considered economically stable, and their currencies are regularly in demand due to their global trading volumes.

When considering what factors affect currency exchange rates, there are lots of different elements that contribute to the value of each currency, some of which can cause rapid changes in the market value, sometimes by the minute:

  • Inflation rates. Lower inflation rates generally cause an appreciation in the currency value. Inflation impacts the prices of goods and services within a country, and consistently lower inflation means a rising currency value. 
  • Interest rates. Where interest rates rise and the cost of borrowing increases, lenders in that country earn higher revenues. This typically drives up foreign capital investment, and therefore growth in exchange rates.
  • Current account balance. This is the “bank account” for a country and shows the level of national debt, owed or owned. Government debt means foreign investors sell their bonds on the open market and can cause a drop in the exchange rate.
  • International trade. The more in demand a country’s exports, the higher the revenue earned. This leads to more demand for the currency and an appreciation in the currencies value.
  • Political stability. Political uncertainty can directly impact the economic stability of a country. Nations with sound trade policies attract more foreign capital, whereas places experiencing instability usually see a drop in exchange rates, as forgein investors become hesitant to keep their money tied up in potentially dangerous situations.

Another factor to consider is speculation. When investors predict an increase in the value of a currency due to any of the above factors, it may experience an increased demand on the FX market. With this increased demand comes a bump in the currency’s value — and so, in some cases, the speculation itself may be the driving factor behind an increase in the exchange rate, even if the anticipated event behind the speculation does not materialize.

How Can I Avoid Risks in the Value of My International Money Transfers?

Most of us will need to send money abroad or use a currency different from our own at some point. That might be in the form of cash for a vacation, sending money to friends and family overseas, or for a business transaction in a different country.

Given how rapidly exchange rates can rise and fall, and the substantial impact on the value of your transfers, it’s always important to know that you’re getting an exchange rate that reflects a fair value.

There are a few things you can do in advance before making an international money transfer that will ensure you know when it’s the right time to make your foreign exchange. They include:

  • Keep an eye on exchange rates. If they’re gradually moving up or down without any sign of slowing, it might be advisable to make your exchange as quickly (or as late) as possible, depending on which favors you.
  • Book in a money transfer at a locked-in rate with an international transfer provider. Having a guaranteed rate means you can go ahead with your plans without worrying that your transfer will suddenly decrease in value.
  • Use a multi-currency account if you’re regularly trading in another currency. This type of account, such as the one Cashero offers, is an excellent option for businesses buying or selling overseas or for frequent travelers who don’t want to be exposed to the risk of currency fluctuations.

While nobody can stop exchange rates from changing, if you have a scheduled transfer, make a regular payment in a forgein currency, or have upcoming travel plans, you can book your exchange rate in advance to protect yourself from an unexpected drop in value.

What is a Forward Rating on a Foreign Currency Exchange?

Simply put, a forward rating is a foreign exchange rate contract for a set date in the future. For example, let’s say you have a trip planned and expect to need $1,000 for your travel expenses. If the currency in your destination experiences a sudden change in it’s exchange value, you could find that in a month when you set off, your $1,000 is suddenly worth 10% less than when you booked your flights. Conversely, of course, it could be worth 10% more — which is why it’s always worth speaking to a professional money transfer provider for an estimate as to what changes they are predicting!

To avoid the uncertainty and ensure you know exactly how much your foreign exchange will be worth, you can book in a forward rating now, which typically will last for a fixed period — usually between 30 and 90 days.

Businesses needing to exchange funds into another currency can also opt for an option forward foreign exchange contract, if they don’t know the exact date when they will require the funds, but know it will be within a general period of time. Options mean that you have a window of time during which you can call on the pre-agreed exchange rate, at which point the contract will mature.

If you’re thinking of booking a forward rate, it’s vital to shop around and ensure you use a dedicated money transfer or foreign exchange service. Mainstream banks tend to offer less competitive rates since they don’t specialize in Forex transactions. There are also other elements such as account fees, transaction charges, and processing expenses, all of which you need to add to the exchange rate to know exactly what costs you are looking at.

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As of the date of publication, the information contained on this page is deemed to be factually accurate for all terms of conditions, features, and fees. Changes made to Cashero’s terms of conditions, features, or fees after the publication of this content may not be accounted for.

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