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Factors determining the fluctuation of currency rates

A foreign exchange, or currency rate is simply the price of one country's money in terms of another country's money. Although exchange rates are affected by many factors, ultimately currency prices are a direct result of supply and demand forces. Supply and demand for any given currency is the result of several different factors and is influenced by several various elements. These elements generally fall into following categories:

• economic factors,
• political conditions,
• market psychology,
• Fundamentals (check major economic releases before that happen check)
• Interest Rates
• International Trade

Economic Factors

1) Government budget deficits or surpluses.
2) Balance of trade levels and trends illustrate the demand for goods and services and it reflects the competitiveness of a nation's economy.
3) Inflation levels and trends (because inflation erodes purchasing power and thus, demand for that particular currency).
4) Interest rates (the higher the prevailing rate, the higher the demand for that currency).
5) Economic growth and health such as gross national product, employment levels, and retail sales can all reflect the strength or weakness of a country's currency.
Political Conditions 1) Instability can have a negative impact on a nation's economy. 2) A fiscally responsible political faction can have a positive effect on the economy. 3) One nation's political climate may have an impact on its neighboring countries' economic health.

Market Psychology

1) Currencies of greater demand are perceived as stronger and are known as "flight to quality".
2) Long-term business cycles and the longer-term price trends that may arise from economic or political conditions.
3) A market that has been "oversold" or "overbought" may reflect the impact of a particular action before it occurs and, when the anticipated event comes to pass, react in exactly the opposite direction.

Fundamentals

Currency prices reflect the balance of supply and demand for currencies. Two primary factors affecting supply and demand are interest rates and the overall strength of the economy.

Economic indicators such as GDP, foreign investment and the trade balance reflect the general health of an economy, and are therefore responsible for the underlying shifts in supply and demand for that currency.

There is a tremendous amount of data released at regular intervals, some of which is more important than others. Data related to interest rates and international trade should be examined most closely.

Interest Rates

If the market has uncertainty regarding interest rates, then any bit of news regarding interest rates can directly affect the currency markets. Traditionally, if a country raises its interest rates, the currency of that country will strengthen in relation to other countries, as investors shift assets to that country to gain a higher return.

Hikes in interest rates, however, are generally bad news for stock markets. Some investors will transfer money out of a country's stock market when interest rates increase, causing the country's currency to weaken. Which effect dominates can be tricky, but generally there is a consensus beforehand as to what the interest rate move will do.

Indicators that have the biggest impact on interest rates are PPI, CPI and GDP. Generally, the timing of interest rate moves is known in advance. They take place after regularly scheduled meetings by the BOE, FED, ECB, BOJ and other central banks.

International Trade

The trade balance shows the net difference over a period of time between a nation's exports and imports. When a country imports more than it exports, the trade balance will show a deficit, which is generally considered unfavorable.

For example, when the U.S dollar is exchanged for other domestic national currencies (to pay for imports), the flow of dollars outside the country depreciates the value of the existing currency.

Similarly if trade figures show an increase in exports, dollars will flow into the United States and appreciate the value of the currency. From the standpoint of a national economy, a deficit in and of itself is not necessarily a bad thing. However, if the deficit is greater than market expectations, then it will trigger a negative price movement.