What Drives Exchange Rates? | Western Union GB Blog (2024)

What causes exchange rates to change? If you need to change money into another currency, you might see that exchange rates keep fluctuating. This means you could get more for your money one day than you would the next.
So, what affects exchange rates? The main factors causing currency fluctuation include:

  • Inflation
  • Interest rates
  • Recession
  • Speculation;
  • Political stability
  • Current account deficits
  • Terms of trade
  • Government debt
  • Stock markets

Here, we’ll dive into these main causes of currency fluctuation to see what causes exchange rates to change.

Inflation

One of the main factors that can cause currency fluctuation is inflation. When a country experiences high inflation, its currency becomes less valuable because it can buy fewer goods and services. This makes it less attractive to investors, and the demand for that currency decreases, causing its value to drop.
On the other hand, if a country has low inflation, its currency becomes more valuable, and it may attract more investors.

Interest rates

Another factor driving exchange rate fluctuations is interest rates. When a country raises its interest rates, it can attract more foreign investment as investors seek higher returns. This can increase the demand for that currency and cause its value to rise.
However, when a country lowers its interest rates, it may become less attractive to investors. This can result in a decrease in demand for that currency and cause its value to fall.

Recession

Economic recessions can also have a significant impact on exchange rates. When a country experiences a recession, its economy may shrink, and interest rates are likely to fall. This is often followed by a decrease in consumer spending, which can negatively impact the country’s currency value.
On the other hand, if a country’s economy is growing, investors may see it as a safe and stable investment. This results in the currency becoming more valuable.

Speculation

Another force impacting currency fluctuation is speculation. Investors may buy or sell currencies based on their expectations of future economic growth or political stability. If investors believe that a country’s economy will improve, they may buy its currency, causing its value to rise.
If investors expect a country’s economy to decline, they’re more likely to sell its currency, causing its value to fall.

Stock markets

Stock markets can also shape exchange rates. When a country’s stock market is performing well, it can attract foreign investment, which increases demand for that country’s currency.
However, when a country’s stock market is performing poorly, the opposite happens. It may deter foreign investment, causing the demand for its currency to decrease.

Political stability

Political stability can also have a big impact on currency fluctuation. When a country has a stable government, it gives investors a sense of security. However, if a country experiences political turmoil or instability, it can cause uncertainty and decrease investor confidence, which can negatively impact the currency’s value.

Current account deficits

Current account deficits occur when a country imports more than it exports. When a country has current account deficits, the country has what’s known as a net outflow of money.
It can cause a decrease in demand for the currency as it may be perceived as less valuable due to its reliance on imports.

Terms of trade

Terms of trade refer to the ratio of export prices to import prices. When a country’s terms of trade improve, it means that it’s earning more from its exports than it’s spending on imports. This can increase demand for the country’s currency, causing its exchange rate value to rise.

Government debt

Government debt is another factor that can impact exchange rates. When a country has high levels of government debt, it can make investors nervous, as it may be seen as a riskier investment. This can cause the demand for the country’s currency to decrease, causing its value to fall.

Keep track of currency fluctuation with exchange rate alerts

If you’re waiting for a favourable exchange rate before you change or send money, there’s an easy way to keep track of currency fluctuations. Instead of constantly checking the exchange rate, you can set an alert for when it changes to your desired rate.
With Western Union, you can set up exchange rate alerts to be notified as soon as it changes to the rate you’re waiting for. You can then send money to loved ones abroad right away to get the most foreign currency for your money.
To get started, register for a free account today.

What Drives Exchange Rates? | Western Union GB Blog (2024)

FAQs

What Drives Exchange Rates? | Western Union GB Blog? ›

Many factors go into and can cause them to change. For instance, a currency's value might go up or down due to international trading, policy decisions, investor expectations, the political climate, and the overall economic conditions of the home country.

How does Western Union determine exchange rates? ›

Here's how exchange rates are determined: Supply and demand in the global foreign exchange market—where traders buy and sell currencies based on several economic factors—decide exchange rates.

What drives currency exchange rates? ›

How much demand there is in relation to the supply of a currency will determine that currency's value in relation to another currency. For example, if the demand for U.S. dollars by Europeans increases, the supply-demand relationship will cause an increase in the price of the U.S. dollar in relation to the euro.

What are the factors affecting the exchange rate? ›

7 factors affecting exchange rates
  • Interest and inflation rates. Inflation is the rate at which the cost of goods and services rises over time. ...
  • Current account deficits. ...
  • Government debt. ...
  • Terms of trade. ...
  • Economic performance. ...
  • Recession. ...
  • Speculation.

What are the causes of change in exchange rates? ›

Multiple factors like inflation, interest rates, public debt, economic performance, political stability and economic announcements can cause changes in a nation's exchange rate.

How is the exchange rate decided? ›

The foreign exchange rate is determined in two main ways: a floating rate or a fixed rate. A floating rate is determined on the global currency markets by supply and demand. As a result, the value of the currency will increase if the demand for it is high. The price of a currency will fall if demand is low.

What are most exchange rates determined by? ›

In a floating regime, exchange rates are generally determined by the market forces of supply and demand for foreign exchange. For many years, floating exchange rates have been the regime used by the world's major currencies – that is, the US dollar, the euro area's euro, the Japanese yen and the UK pound sterling.

What are the key drivers of exchange rates? ›

The main factors causing currency fluctuation include:
  • Inflation.
  • Interest rates.
  • Recession.
  • Speculation;
  • Political stability.
  • Current account deficits.
  • Terms of trade.
  • Government debt.
Jan 9, 2024

What is manipulating the exchange rates? ›

Currency manipulation is a policy used by governments and central banks of some of America's largest trading partners to artificially lower the value of their currency (in turn lowering the cost of their exports) to gain an unfair competitive advantage.

What controls the exchange rate? ›

Current international exchange rates are determined by a managed floating exchange rate. A managed floating exchange rate means that each currency's value is affected by the economic actions of its government or central bank. The managed floating exchange rate hasn't always been used.

What makes currency go up or down? ›

Currency fluctuations are a natural outcome of floating exchange rates, which is the norm for most major economies. Numerous factors influence exchange rates, including a country's economic performance, the outlook for inflation, interest rate differentials, capital flows and so on.

What is the greatest factor affecting a country's exchange rate? ›

Economic or Monetary policy decisions are often regarded as the most influential factor over foreign exchange (FX) rates. Central banks, like the Federal Reserve, use monetary policy to manage fluctuations in the economy and keep prices stable.

What affects the US exchange rate? ›

What Factors Influence the Exchange Rate? Factors that influence the exchange rate between currencies include currency reserve status, inflation, political stability, interest rates, speculation, trade deficits and surpluses, and public debt.

What increases exchange rate? ›

Differentials in Interest Rates

Higher interest rates offer banks and other lenders a better return relative to other countries. Higher interest rates attract foreign capital and cause the exchange rate to rise.

Which of the following factors influences exchange rate? ›

Numerous factors influence the demand and supply of currencies, as seen in the image below. The most important factors are interest rates, inflation rates, economic and political stability, market expectations, and market liquidity & volume.

How do exchange rates work for dummies? ›

The exchange rate gives the relative value of one currency against another currency. An exchange rate GBP/USD of two, for example, indicates that one pound will buy two U.S. dollars. The U.S. dollar is the most commonly used reference currency, which means other currencies are usually quoted against the U.S. dollar.

How is the exchange rate calculated? ›

If you don't know the exchange rate, you can use the following simple currency conversion calculation to find it: take your starting amount (original currency) and divide it by ending amount (new currency) = exchange rate.

What determines the exchange value of a currency? ›

The value of a currency, like any other asset, is determined by supply and demand. An increase in demand for a particular currency will increase the value of the currency, while an increase in supply will decrease the currency's value. The exchange rate is the value of one country's currency in relation to another.

How do you get the best exchange rate when transferring money? ›

Use a specialist provider

There are many specialist providers that offer better exchange rates and lower fees than traditional banks. Specialist providers include companies such as Veem, XE, and OFX. These providers typically have lower overhead costs and can pass on the savings to their customers.

How much does Western Union charge to send $1000? ›

Assuming you're sending bank-to-bank, Western Union generally charges between $6.47 and $37.60 to send $1,000. However, the costs could still be higher if you choose a different sending or receiving method. How much does Western Union charge to send $5,000?

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