If your business is involved with trade between different countries, or needs to make payments abroad, you will no doubt have an interest in currency exchange rates and will have noticed the impact a sudden rate change - for better or worse - can have on the profitability of each transaction. Fluctuation in currency rates can drastically alter how much money you pay or receive for a service or goods purchased or sold to someone in another country, so it is important to trade at the right time.
It is often difficult to keep up with currency exchange rates, as they are moving constantly throughout any day. But developing an understanding of the reasons why rates fluctuate so much will help you to judge the potential impact of any international transaction on your business - and its bottom line.
So what are the main factors that can influence exchange rates?
A country's inflation rates have a significant impact on the value of its currency. Inflation is the rate at which a country's services and goods increase in price. If you are dealing with a country that has a low inflation rate, this will have a positive impact on its currency, which will become more valuable. On the flipside, countries that have high rates of inflation will see their currencies lose value. This is because high inflation in a country means that the price of its goods is increasing quicker than that of various other countries, so these goods lose their competitive edge. Export demand for these products will decrease, and therefore so will the demand for that country's currency.
When interest rates are higher, a country's currency will usually appreciate this trend. This is because, when the base interest rate is higher, so are the rates for lenders. This attracts more investment into a country's economy from foreign investors, which in turn will cause its currency exchange rates to rise. A lower base rate, on the other hand, will mean low-interest rates and therefore less investment.
If a country has a particularly volatile government, this will have a negative impact on the value of its currency. Countries that are at risk from sudden or long-term turmoil will be vulnerable to a dip in their currency because they will not be an attractive prospect for investors. Those countries that are politically stable often are the most attractive to foreign investors, and therefore will see their exchange rate increase; this is why the GBP, the Euro and the US Dollar remain among the strongest currencies in the world.
If a country has a large amount of government debt - that is a public debt owed by the government - it will be a less attractive prospect to foreign investment. When there is less capital invested in a country, there are fewer sales of its good and services from foreign buyers, leading to inflation. The value of the country's currency will then depreciate as a result.
Recession has a very significant impact on a country's currency. When a country goes through a financial crisis or recession, it will be less attractive to foreign investors and less likely to attain foreign capital. This will lower interest rates and weaken the country's currency. Countries that are financially stable or with fast-growing economies - such as emerging markets - offer investors a more attractive prospect. These are the countries that will see their currencies rising along with their GDP.
Every country has a type of current account, which shows a balance of import versus export value. If a country is spending more money on importing goods and services than it is earning in exports, this can cause the country's currency to depreciate. As this balance fluctuates, so does the rate of currency exchange.
When there are major events on the horizon, or major predictions about any of the above factors, the knock on effect can be fluctuations in a country's currency. Talk in the media or other public entities that a currency is about to increase in value will have investors rushing to buy that particular currency. This in itself can cause a temporary impact on currency exchange rates.
If you are planning to trade currencies or need to make business payments abroad, make sure you keep an eye on all of these factors before making a transaction or entering into business with another market; fluctuations in either direction can often mean the difference between profit and loss.
At The Currency Account we always give you access to the best market rates, helping you to reduce the costs involved in foreign transactions, while our online platform makes the process quick, easy and secure. To find out more, sign up for free.