Many people like to play the currency markets and it can be very lucrative for some. However, currency is one of the most volatile commodities you can trade, and you should proceed with caution as money can be lost as well as made. Here are six factors that influence the currency market.
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Inflation
Most government and national banks make a concerted effort to keep inflation low as it affects the purchasing power of that country as well as the individuals who live in it. It affects the volatility of a currency against others. Generally, countries with high inflation see their currency depreciate against that of other countries. This means that importing goods from abroad becomes more expensive and has a negative effect on the economy.
Interest Rates
Inflation can influence interest rates which in turn can mean that interest rates are increased, making borrowing more expensive and saving more worthwhile. Investment return improves in the country which attracts foreign investors and causes the exchange rate to rise. Decreasing interest rates have the opposite effect.
Public Debt
Countries often borrow money to pay for large-scale public sector projects and government funding. This helps the domestic economy, but it can have a negative effect on its currency compared to other countries. This is because it can lead to inflation. A country may need to lower its prices to remain competitive in international markets which can lead to the value of its currency falling. Foreign investors can compound the problem by being cautious about investing in a particular country if they feel they may default on the debt.
Political Stability
Foreign investors like to think they are investing in a strong market as this lowers their risk. However, political instability can weaken a market as investors don’t like uncertainty. Uncertainty can be anything from the announcement of a general election to the declaration of war. This can cause the currency value to drop.
Speculation
Rumours, as well as forex news, can greatly influence currency markets. A country does not need to suffer from political instability or inflation to cause currency market volatility. If enough investors believe that changes are about to occur, this can affect their desire to invest, so the currency value will change and cause a self-fulfilling prophecy.
The Strength of Other Currencies
Currencies are closely inter-related and the currency market in one country can change because of events elsewhere in the world. For example, during the banking crisis, investors were not confident about investing in the EU or USA markets and many of them put their money into the more stable economic markets of Japan and Asia instead. Even though these economies were growing slowly, their currency value still increased in relation to others.
Currency markets are very volatile because major economic factors are intricately linked. Global markets can easily affect each other which adds to the problem as investors become more cautious. These are just six factors that affect the currency markets, but they should be taken as a whole rather than a series of individual aspects when considering how the currency market is influenced.
Featured image credit: Edited from Pexels
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