Exchange rates between national currencies are essential for the global economy, and how these rates are determined is a critical consideration for countries. Have you ever wondered why the value of your country’s currency changes against other currencies? Many factors can affect exchange rates, and it can be hard to understand what’s going on sometimes. In this blog post, we’ll explore some of the reasons why exchange rates fluctuate and what that means for you.
1. Who Decides the Exchange Rate?
In so-called floating exchange rate regimes, the rate often fluctuates with the balance between supply and demand for foreign currency. When domestic demand for foreign currency increases, it can lead to an appreciation of that currency relative to another as more of it is needed on the market. When domestic demand diminishes, it can result in depreciation as less of that currency is required. So, it is the market forces of demand and supply of foreign exchange that decides the rate.
In addition, central banks in certain countries, such as the United States, may take measures to influence the exchange rate. This is done with tools like increasing or decreasing interest rates or aggressive open market operations through the direct purchase and sale of foreign currencies using the nation’s reserve currency. Nevertheless, when all factors influencing exchange rate movements to come into play at once – including inflation expectations, geopolitical turbulence, and government intervention – it’s traders in specific markets who decide what happens on any given day. (See What are Characteristics of Good Money?)
2. What are Exchange Rate Fluctuations?
Exchange rate fluctuations refer to the changes that occur in the value of a currency relative to another. Generally, these variations are caused by shifts in supply and demand for currencies due to market forces. External factors, including political stability, inflation, and economic growth, can also affect exchange rates. This can create significant opportunities for businesses and individuals to capitalize on favorable exchange rates by investing or making purchases at an advantageous time.
Exchange rate fluctuations also have potential implications for international trade and travel expenses, so it is important to be aware of current rates when engaging in international transactions. Throughout history, currency markets have been subject to extreme fluctuations due to changes in global economies and geopolitical events. As such, understanding how exchange rate movements occur is critical for all stakeholders in the economy.
3. Why Exchange Rates Fluctuate?
Exchange rates are constantly fluctuating and can have a significant impact on the global economy. The exchange rate is simply the ratio at which one currency can be exchanged for another. Knowing why exchange rates fluctuate is important to understand how currencies move in relation to one another.
Basically, currencies fluctuate based on supply and demand; when there is high demand for a certain currency, its value will increase, whereas low demand decreases in value. However, other factors such as economic conditions, political news, trade policies, and monetary policy interventions can also lead to changes in the exchange rate.
National banks often intervene by buying or selling their home currency to maintain their desired exchange rate stability. Therefore, market forces and official actions affect how currencies move against each other and cause exchange rates to fluctuate over time.
4. What are the 4 Factors that Impact the Exchange Rate?
While discussing why exchange rates fluctuate, make a note of the 4 factors that impact the exchange rate:
- Inflation Rates: Inflation measures how much the price of goods and services increases over time. The inflation rate for one currency relative to another will affect its exchange rate. When the inflation rate of one currency is higher than that of another, it tends to depreciate, making it more expensive to buy with foreign currencies.
- Interest Rates: Interest rates play a major role in exchange rate movements. Higher interest rates tend to attract foreign capital and increase demand for the currency, thus causing its value to appreciate relative to other currencies.
- Economic growth: A growing economy signals strength in the currency, and foreign investors are more likely to buy or invest in the currency. This will drive up demand for the currency, thus appreciating its value.
- The current account on balance of payments: It is the difference between the value of a country’s exports and imports. When a country has a surplus, its currency will appreciate due to increased demand for it from foreign investors. On the other hand, when a country has a deficit, its currency may depreciate due to weak foreign demand.
5. Do Exchange Rates Change Daily?
Yes, exchange rates do change daily. So, why exchange rates fluctuate? Exchange rates always fluctuate based on factors like global economic trends, political instability, and relative currency values. As a result, it is important to keep an eye on the exchange rate if you are planning to buy or sell goods abroad.
When foreign currencies are weak, it can be advantageous for companies and consumers to purchase items from overseas markets. Conversely, when one currency is particularly strong, it can open up more opportunities for businesses in that market.
One example is the US dollar which has become increasingly strong in recent years due to increased trade and investment between American markets. As such, foreign companies have benefited from taking advantage of this trend and offering their goods at lower prices in the US than they would normally charge elsewhere. (Also read Who Invented Paper Money?)
6. What Times do Exchange Rates Change?
The foreign exchange market is always open 24 hours a day, five days a week. Exchange rates can change at any time, depending on global economic conditions and news events. So, to comprehend why exchange rates fluctuate, you should always keep a watch on the fluctuating rates every day if you want a better return.
7. Are Exchange Rates Better in the Morning?
It depends on the currency. Generally speaking, exchange rates are better when more traders are open for business. Since more traders are open in the morning, the rates are typically more favorable. However, there can be exceptions to this rule, so it’s always best to consult a currency specialist before making any major transactions.
8. What Currency Fluctuates the Most?
Here is the list of the most fluctuating currencies:
- AUD/JPY
- NZD/JPY
- AUD/GBP
- AUD/USD
- CAD/JPY
9. Which Country has the Highest Currency?
The Kuwaiti dinar is the highest currency in the world. The Kuwaiti dinar is a strong currency and has been relatively stable compared to other currencies in the region.
10. How do You Get the Best Exchange Rate?
It depends on where you are located. Local banks and credit unions usually offer the best rates in the United States. You can also check online exchanges. However, be aware that they charge a fee for their service. See What is the Main Purpose of the Seven-Pay Test?
11. What is the Cheapest Way to Exchange Currency?
Since you know why exchange rates fluctuate, here are some cheapest ways to exchange currency:
- Stop by your local bank – One of the most affordable ways to exchange currency is to visit your local bank. Banks typically have competitive exchange rates and may even waive their fees or offer special promotions. Plus, you can usually get your cash quickly if you go into a branch—some banks even offer same-day delivery.
- Get traveler’s checks – If you’re making a large purchase overseas, traveler’s checks are another good option. Most banks will allow you to purchase them in your local currency, which can be exchanged at any bank or money exchange kiosk abroad. The downside is that you’ll likely have to pay a fee for the service.
- Buy currency at your foreign bank branch – They may offer the best exchange rate if you have an account with a foreign bank. They may waive fees or offer other incentives to encourage you to use their services. Just be sure to check with your bank ahead of time to ensure they provide currency exchange services.
- Order currency online – Ordering your currency online may be the way to go if you’re looking for convenience. Most online exchange providers offer competitive rates and can even deliver your cash directly to your door in a few days. Just be sure to shop for the best rates before making a purchase.
- Use an ATM abroad – Using an ATM is usually the fastest and most cost-effective option if you’re traveling abroad and need to exchange currency. Most ATMs overseas will allow you to withdraw money in the local currency at a good exchange rate. And, since there are no fees associated with this method, it’s often the cheapest way to get the exchange.
The article has looked at some of the main reasons why exchange rates fluctuate so significantly. Political stability, inflation, and interest rates are just some of the things that contribute to these changes. As a business owner or an individual looking to make an international transfer, it’s important to be aware of these factors to budget effectively.
