Foreign exchange rates for a country indicate its economic health and
plays a high important role in its trade level. This why that rates are
constantly scrutinized and analyzed. For the individual investor,
these rates often have an adverse effect on their portfolios. Trading activities between countries is the main factor that affects currency rate fluctuations.
When a country shows an increase in its currency rate, its export prices
will increase, and its import prices will drop in the foreign market.
The reverse is true when a country has a low currency rate.
If a country has a low exchange rate, its trade balance will increase,
but a high exchange rate will decrease its trade balance.
Current Account Deficit
The trade difference between a country and its trade partners is termed
as a ‘current account.’ It shows the difference between payments made
from one country to another for interest, dividends, goods and
services. A deficit in a country’s current account
shows that it is spending more on foreign trade than it is earning from
other countries. It is also indicative of the fact that a country
requires funding from foreign sources to get rid of its deficit. This
indicates that a country requires more foreign currency than it is earning from its exports. This means that the demand for its products is not very high.
Interest Rates
The correlation between inflation, interest rates and foreign exchange
rates is extremely strong. If central banks make the decision to
manipulate interest rates, there is a direct influence on inflation and
the currency exchange rate. By raising the interest rate, lenders
achieve a higher return than in other countries. This attracts
investment from foreign countries which causes an increase in the
exchange rate. When interest rates are brought down, the return for
lenders decreases which brings down the exchange rate.
Inflation
If a country has a consistently low inflation rate, its currency value
will increase. This is so because the country’s purchasing power
increases in relation to foreign currencies. The countries who
maintained low inflation rates during the past fifty or so years are
Germany, Japan and Switzerland. Low inflation in North America was only
achieved much later. Countries that have a high inflation rate
experience a dip in their currency rate as opposed to their trade
partners. This phenomenon is linked to high interest rates.
The foreign currency exchange rates linked to your investments will be
the determining factor of the actual value of your investment
portfolio. There are a huge number of factors that determine a
country’s exchange rate and these are complicated enough to leave many
experienced traders confused. If you are an avid investor or foreign
currency trader, you should become familiar with concepts that determine
currency values. These rates will have a dramatic effect on the return
on your investments.
Foreign currency exchange rates have impact on individual consumers and companies who trade with other countries.
