In addition to inflation and interest rates, currency exchange rates are often used to measure a country’s economic level. Currency exchange plays an important role in inter-state trade, where most of the countries in the world today are involve in free-market economic activities. For investment companies and foreign investors, the exchange rate will affect the return and investment portfolio.
The exchange rate of a country’s currency is relative, and expressed in comparison with the currencies of other countries. Of course, the exchange rate changes will affect the trading activities of both countries. A stronger exchange rate will cause the country’s export value to be more expensive, and imports from other countries are cheaper, and vice versa. Here are 6 factors that can affect the movement of currency exchange rates between 2 countries:
1. Differences in inflation rate between 2 countries
A country with a consistently low inflation rate will have a stronger currency exchange rate than a higher inflation country. The purchasing power of the currency is relatively larger than other countries. At the end of the 20th century, countries with low inflation rates were Japan, Germany and Switzerland, while the United States and Canada followed later. Currency exchange rates of countries with higher inflation will be depreciate compare to their trading partner countries.
2. Differences in interest rates between 2 countries
Interest rates, inflation and exchange rates are closely link. By changing the interest rate, a country’s central bank can affect inflation and currency exchange rates. Higher interest rates will cause the country’s currency demand to increase. Domestic and foreign investors will be attracted by a bigger return. But if inflation returns high, investors will come out until the central bank raises interest rates again. Conversely, if the central bank lowered interest rates it will tend to weaken the exchange rate of the country’s currency.
3. Trade balance
The trade balance between the two countries contains all payments from the sale and purchase of goods and services. A country’s trade balance is called a deficit when it pays more to its trading partner country than the payments earned from trading partner countries. In this case the country needs more currency trading partner countries, which causes the exchange rate of the country’s currency against its partner country weakened. The opposite is called a surplus, where the exchange rate of the country’s currency strengthens against the trading partner country.
4. Public debt (Public debt)
A country’s domestic budget balance is also used to finance projects for public and government interests. If the budget deficit then the public debt swell. High public debt will cause an increase in inflation. The budget deficit can be closed by selling government bonds or printing money. Things can get worse if a large debt causes the country default (default) so that the debt rating down. High public debt will obviously tend to weaken the exchange rate of the country’s currency.
5. Ratio of export price and import price
If export prices increase faster than import prices then the exchange rate of the country’s currency tends to strengthen. Demand for goods and services from the country is rising which means the demand for its currency also increases. The reverse situation for import prices is rising faster than export prices.
6. Political and economic stability
Investors will certainly look for countries with good economic performance and stable political conditions. Countries with unstable political conditions will tend to be at high risk as a place to invest. The political situation will have an impact on economic performance and investor confidence, which will ultimately affect the exchange rate of the country’s currency