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Currency Markets

Factors Affecting The Currency Markets

A stock's value is based on the expected future earnings, as the expectation increases, the value of that stock goes up. Exchange rates, on the other hand, are affected by a completely different set of factors, out of which, one of the most important factor is a currency's supply and demand. The currency markets of the world can be viewed as a changing mix of current events. The volatile nature of current world events, and, the constant shifting of supply and demand can lead the price of a currency to always be on the move. Forex is the most affected market in the world because of many external factors.


Supply and demand for a currency are influenced by several factors. These falls into three categories:

  • Political conditions
  • Market psychology
  • Economic factors

Political Conditions:

A country’s political condition plays a vital role in its currency movements. An economy faces a negative impact at times of political turmoil, and if a nation has elected a new government that is seemed as "economically friendly" favorable economic and trading conditions may result. Political events both inside and outside a country can have a huge impact on a nation’s economy and currency. 


Market Psychology:

To explain this factor we will take the example of Brexit and how it impacted:

In recent years, Brexit has been a very major event. The Great Britain Pound fell by 8.64% when this news occurred, and is a very big percentage while dealing in currencies.

Brexit as the name suggests is Britain exiting the European Union. On June 23rd, 2016, the citizens of Europe were told to vote for or against Britain exiting the EU. The results were a bit shocking because almost everyone in the world believed that Britain would stay in the EU.

When the UK decided to exit the EU, there were both political as well as economic impacts.  Considering the magnitude of the event, there was a lot of uncertainty, and panic among the people, which led to investors being bearish and this is what led to the crashing of GBP to a 31 year low.


Economic Factors:

The government's economic policy and conditions can have a big impact on its exchange rate. The economic policy includes a government’s fiscal policy, budget policies, government spending, etc. Monetary policy is controlled by a nation's central bank (RBI) and includes the interest rate and the supply of currency.  


The following are some of the economic factors that affect the currency markets:

  • Deficits & Surplus:

The wider a nation's deficit, the lower its currency and trade value, and vice-versa.

  • Trade levels and trends: 

The more a nation is involved in trades, the higher the demand will be for its currency to perform these trades, which increases the value of its currency and vice versa.

  • Inflation:

The higher a nation's inflation rate, the lower the value of its currency. CPI or the Consumer Price Index is an index that measures inflation.

  • Economic figures and reports: 

Key economic data such as GDP (gross domestic product), employment, and unemployment levels, goods sold, can offer an insight into a nation's growth and health. Economic figures that people pay constant attention to include, inflation, (un)employment, trade figures, and money supply. Country's economic reports, outlining its GDP (Gross Domestic Product), NNI (Net National Income), GNI (Gross National Income), NNP (Net National Product), GNP (Gross National Product) are also important variables. Commonly, the healthier a country's economy, the better its currency performance will be, which will then generate a higher demand for it.

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Units 5/12