Foreign exchange rates play an important role in the level of country`s trade. It is very critical in the free market and also the world economy. Foreign exchange rates are the most analysed and watched by governments to find ways to manipulate economic measures. Apart from government, they also affect investor`s portfolio. There the major forces that influence foreign exchange rates especially in investing.
The first force is the difference in inflation. A country or state that consistently have a lower rate of inflation is advantageous because the value of the currency is usually high. The purchasing power of money and stock are relatively high with the currencies that are usually stable in the market. Countries that usually have a low rate of inflation are Germany, US, Canada, Switzerland and Japan. Countries that have a high inflation rate are disadvantaged because the level of interest rates are very high.
The second thing is the difference in the level of interest rates. Foreign exchange rates and inflation are highly correlated. Central banks have a great impact on both exchange rates and inflation. Changing the interest rates in the market will, in turn, affect the exchange rate of currencies. The countries with high-interest rates attract many foreign capital and investors. The opposite is also applied to countries with lower interest rates.
Another thing that affects foreign exchange rate is current account deficit. The current account is simply a balance of trade between an investor and its trading partners. It is reflected in all payments such as interest, goods, dividends and services. A deficit shows that a particular investor is spending more on forex trading market than what is actually earning. An investor requires receiving more sales and supply of currency that other trading partners.
Personal debt also affects investor. If a person engages in borrowing capital a lot the balance of trade will go down. Large debt does not attract trading partners. Large debt encourages personal inflation, and the price of the market will be low. This also affects the country` economy because the countries with large debt because of borrowing is less attractive to foreign investors.
Terms of trade also affects foreign exchange rates. Terms of trade are the relationship between the balance of payments and current account. The demand for a certain currency should be high to attract more people. The value of the price will be high if there are favourable terms of trade. The interest rate will, in turn, rises. The investor will end up earning more in the market because terms of trade are favourable.
Another thing that usually affects investors a lot in the forex market is the economic performance and political stability. Foreign investors prefer countries that have a strong economic performance so that they can invest in their capital. The Foreign investor will draw funds from countries that the political and economic performance is at risk. The political stability of a particular country creates confidence to investors because the movement of capital is very stable. The risks rate is extremely low.