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Like any price, the exchange rate deviates from the cost basis - the purchasing power of currencies under the influence of supply and demand of currency. The ratio of the supply and demand depends on several factors. It reflects connections with other economic categories - cost, price, money, interest, balance of payments, etc. There is a complex of interweaving and nomination of decisive factors. Among them are the following.
payments leads to a tendency to a decrease in the national currency's exchange rate as domestic debtors try to sell everything using a foreign currency to repay their external obligations. The size of the impact of balance of payments on the exchange rate is determined by the degree of openness of the economy. Thus, the higher the share of exports in gross national product (the higher the openness of the economy), the higher the elasticity of the exchange rate. In addition, the exchange rate affects economic policy of the state in components of the balance of payments: current account and capital account. For example, the effect of changes in tariffs, import restrictions, trade quotas, export subsidies has an impact on the trade balance. When the positive balance of trade is on the advance there is an increase in the demand for the currency of the country that raises its rate, and in case of negative balance the reverse process occurs. Movement of short-term and long-term capital depends on the level of domestic interest rates, restrictions or encourage of import and export of capital. Changes in the balance of capital have an impact on the currency, which is similar to the trade balance by its mark (plus or minus). However, there is a negative influence of excessive short-term capital inflows into the country on the rate of its currency because it can increase the excess money supply, which, in turn, may lead to higher prices and the depreciation of the currency.
The influence of this factor on the exchange rate is explained by two main factors. First, changes in interest rates in a country affect, all else being equal, international capital flows, especially short-term ones. In principle, an increase in the interest rate stimulates the inflow of foreign capital and its cutting promotes the reduction of outflow of capital, including national. That is why in a country with higher interest rates capital comes into, the demand for its currency increases, and it becomes expensive. The movement of capital, especially speculative "hot" money, increases instability of the balance of payments. Secondly, interest rates affect the operation of foreign exchange markets and money markets. When executing transactions, banks take into account the difference in interest rates on national and global capital markets with a view of deriving of profit. They prefer to get cheaper loans in foreign money markets, where rates are lower, and place foreign currency on the domestic credit market, if its interest rates are higher. On the other hand, the nominal increase in interest rates in the country reduces the demand for domestic currency as receipt of credits becomes expensive for business. In case of taking out a loan, an entrepreneur increases the cost of their product that, in turn, leads to higher prices for goods inside the country. This relatively devalues the national currency against a foreign one.
8.Market factors.These factors can significantly change the value of currency at short intervals.
Thus, the overall expectations for future economic growth, changes in fiscal and foreign trade deficits directly affect the exchange rate. In addition, the foreign exchange market participants' expectations have a significant impact on the value of the exchange rate. Seasonal peaks and downs of business activity in the country have a significant impact on the rate of national currency.
Short-term factors
Interest rates: a government may decide to lower interest rates in an attempt to stimulate growth in the economy. Generally, this means that investment funds will flow out of one currency into another currency that has higher interest rates. So when looked at in isolation, lower interest rates could weaken the currency.
Trade flows: a trade surplus is where there is a greater demand for goods and services from a country, which means its currency (needed to pay for those goods) will be stronger. Conversely, a trade deficit will usually weaken the currency.
Natural disasters: think about the earthquakes in Japan and New Zealand and the effect this has had on their currencies. The currencies initially weakened on the events due to the unknown damage made to the economy. They then strengthened as insurance funds and other sources of funding flowed back to these countries from overseas to fund the repairs. Then the currencies weakened due to action taken by their central banks to aid economic recovery, such as injecting additional funding into the financial market and reducing interest rates, had a negative impact on the currency.
Economic growth: an investor may choose to hold one currency over another simply because that country is growing at a faster pace than the other or is perceived to do so in the future. Links to commodity based currencies: currencies such as Norwegian Krone or Canadian dollar are commodity linked currencies and their exchange rates tend to increase in value when there is a rise in commodities such as oil. Conflict: there may be a period of time where there is no official government in place or when a person or organisation has taken power illegally. This will naturally have an effect on the currency and will be ongoing as the conflict continues.
Short term inflation: if inflation is starting to rise then the natural response for the authorities will be to limit the rise of inflation by increasing interest rates, therefore clients may convert into that currency in anticipation of gaining a better return on their money.
Long-term factors
Long term inflation: this is a rise in the general level of the prices of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services. Consequently, inflation wears away the purchasing power of money in that country. So higher inflation in a country typically weakens its currency.
Economic growth: it can take many years for an economy to recover i.e. the subprime crisis in the US took place over three years ago, and it has taken many years for the US economy to recover to the level it's currently at.
directly the rise in price, standard currency value corresponding falling. 4Interest rate When a countrys leading interest rate is rise or drop in another country, it will be pursue the higher retaliate on fund, the low interest rate currency was sold, but the high interest rate currency is buying. Because relative high interest rate currency demand has increased, therefore this currency will revalue to other currencies. Let see an example explain how the interest rate does affect the exchange rate There are country A and country B, both countries do not execute the foreign exchange control, the fund is free flowing between two countries. As a A country monetary policy part, an interest rate of this country had been rises 1%. Simultaneously the B country's interest rate level is invariable. A amount of floating capital into market, the fund will supply with a loan at the most favorable rate between nations. But when other conditions invariable A country's leading interest rate upward, the large amount shortterm floating capital can flow in the A country to pursue a higher interest rate. When the floating capital flows out from the B country, the large amount B country currency is sold exchanges the A country currency. Like this regarding the A country currency demand rise, its result is A the country currency relative B country currency walks strongly. The point of the example is situation regarding both countries between. In fact, the market became internationalization today, it similarly practical in global. For years, the fund free flowing and the foreign exchange control elimination has been ultimately. This trend is the free flow of international short-term hot money (sometimes called "hot money") provides a great convenience. There is a noticeable that only when the investors that the exchange rate movements do not offset the return of the high interest rates, funds transferred to the high interest rates of regional or national. 5The market judgment The foreign exchange market always does not follow a logical change. Factors that difficult to understand including personal feelings, the judgment, the analysis for various global politics , economical event, understanding the impact of exchange rate. The market operator must correct understanding of a variety of published reports or data, such as foreign exchange income and expenditure data, indicators of inflation, economic growth rate. But in fact, before reporting a data to the open market, there will be a data reflection true expectation or judgment in the market. This expectation or judgment will be report in public and the data reflected in the price. If appears the real report either the data and the people anticipated the wide difference, it will lead to exchange rate fluctuation. The only correct understanding of the various economic indicators and data is not enough for a foreign exchange dealer. He must understand what expected and judge of the market indicators and data on unpublished. 6Speculation Speculation of the market operator also is an important factor affecting the exchange rate. The percentage of the transaction direct and the international trade in the foreign exchange market is not high on the other hand. Most of the transactions from the essence are the congenial behaviors, congenial behavior will cause the different currency the flowing, thus will have the influence to the exchange rate. When people analyze the factors of exchange rate to obtain some kind of currency exchange rate to rise, the competition rushed to purchase, then became this currency rise the reality. Otherwise, when the people anticipated some currency will fall, will be able to compete to undersell, thus will cause the exchange rate to glide down. For example, after the World War II period of time, politics of United States stability progressively, the economical movement is good and the inflation rate is low, but the economy grows in the beginning of the 60's reaches yearly average 5%. The various countries willing to take the U.S. dollar as a means of payment, store of wealth, so that the U.S. dollar exchange rate to rise continually. However, the early 1970s to the late 1960s, because of the Vietnam War, Watergate scandal, serious inflation and increase the tax burden, the trade deficit and economic growth have declined, so that the value of the dollar fell sharply.