Exchange rates play a vital role in any economy. Important factors such as economical confidence, political stability, interest rates, inflation rates, balance of payments, and current account deficit or stability determine the future of exchange rates.
Let’s understand this with an example. The overall demand for the Canadian products will rise if the Canadian business becomes competitive in the market. The rise in demand for Canadian goods will automatically increase the value of Canadian Dollar.
Conversely, if economists are uncertain about the stability and growth of the Canadian market then the CAD will become weaker as compared to stable economies. It means supply and demand has great importance in determining exchange rates.
Here are a few important factors that act upon exchange rates.
The currency value of a country with low inflation rate becomes stronger. If you want to get money back alongside extra profits, then consider investing in a currency that has low inflation rate. For instance, if the inflation rate is relatively lower in the US, then the US exports will automatically become inexpensive. This will give rise to overall demand of US goods in the international market. Hence, the USD will become more powerful.
If forecast experts predict the USD to go up in the near future, the demand for the American dollar will rise. Everyone would like to invest in a currency that will be giving a bunch of profits after a short wait. The increase in demand of USD will become the reason of increase in its value. That means the value of exchange rate is also determined by the sentiments and market predictions. Speculations of the financial market can cause a specific currency to go up or down.
If the interest rate rises in a specific economy, people are tend to make more investments there to get a better return on investment. For example, if the interest rate in the US grows then people will deposit money into US banks to take benefit of increased interest rate. This will give rise to demand in the USD. Some Forex trading scams are likely to spread false information about interest rates. Try to stay away from them by checking true information on authentic sites.
So, always remember the simple rule that high interest rate makes a currency stronger while a low interest rate makes it weaker in the financial market.