World global economy represents the full image of all the world’s national economies. It can be evaluated by various factors among which the currency of a given country is of utmost importance. The price of one currency in relation to another is constantly changing due to the world events and the constant shifting of currency’s demand.
There exist several distinct factors affecting the supply and demand of a given currency. Those factors fall into the following three main categories: economic factors, political conditions and market psychology. In the given article we’ll discuss the main economic factors affecting the currencies.
Economic factors convey economic conditions and governmental economic policy. The latter includes spending, budget policies and monetary policy. Monetary policy is under the control of nation’s central bank and involves interest rates as well as the supply of currency.
Economic factors or here as they may be called economic events greatly affect the value of currencies. Now let’s understand what are the economic events influencing currencies.
1. Economic policies in separate countries
According to the Management of Financial Institutions economic policies concern the country’s governing of budget, trade and currency distribution. In the parliaments around the world the budget readings are essential for individuals to invest in the country’s currency.
The currency’s value tends to increase if the budget is well balanced, promoting trade and improved economic status. On the other hand the value of the currency will reduce if the distribution of economic policies as reflected in the budget is not satisfactory.
2. Deficits and surpluses
Based on the data of Federal Reserve Bank of San Francisco we can say that greater the country’s surplusis, the stronger its currency will be.
The strongest currencies belong to countries with fewer deficits. Conversely countries having many deficits or liabilities have a weaker currency. For an ideal state of a country there should be a balance of deficits and surpluses.
3. Interest rates
Governments sometimes make a decision to lower the interest rates in order to stimulate the growth of economy. When interest rates go up this leads to an increased demand and causes an increase in the value of the currency. If interest rates go down, this may lead to a flight from that currency to another.Generally, this means that investment funds will flow out of one currency into another currency that has higher interest rates.
The lower is the country’s inflation, the higher is the value of its currency.
Basically inflation reduces the value of a currency;however the rate of inflation should be reasonable as it occurs in every country. People invest in currencies belonging to countries of a manageable inflation rate as they are reliable and in high demand. Here we should mention two terms of inflation:Short term and long term inflations. Together with the emergence of short term inflation the authorities as a natural response limit the rise of inflation by increasing interest rates.
Over a period of time the price rise of goods and services in economy defines long term inflation. Because of the increase in price level by each unit of a currency can be bought fewer goods and services.
As a result of inflation the purchasing power of money disappears in that country.
5. Economic growth
According to the data presented by Barclays strong economy supposes strong currency. However the economic growth of one country is a prolonged process; it usually takes many years for an economy to recover. For instance after the subprime crisis in the USA which took place over three years ago, many years were required for the US economy to recover and reach its current state.
6. Unemployment rate
Employment levels have a direct influence on the economic growth. Because of the unemployment increase the consumer spending falls. An increase in unemployment indicates a slowdown in the economy and the possible devaluation of a country’s currency due to the lower demand and declining confidence.
Commodity linked currencies like Canadian dollar or Norwegian Krone tend to increase in value due to the rise in commodities such as oil.
Thus, the diverse and intricate nature of economic events and their direct influence on currencies were illustrated. It became evident that currency price fluctuation does not take place accidentally and that it is a consequence of serious changes occurring in the world economy.
- Zeepedia.com, 2012. Foreign Exchange: Factors affecting currency trading
- frbsf.org; Federal Reserve Bank of San Francisco; Education: Why does a trade deficit weaken the currency?
- barclayswealth.com: Factors that affect currency rates
- investopedia.com; Investing: 6 Factors That Influence Exchange Rates
- articlesbase.com: The 8 Economic Factors that Affect the Forex Market
- investorguide.com; Articles: Can Commodities Affect Currency Rates?