Fundamental Analysis: Factors that Affect Currency Prices
One method that is used to analyse the Forex market is fundamental analysis. Traders analyse all the economic and political factors that affect the currency value and the market trends. As the forex market operates globally, the market is influenced by the economical and political news that occur around the world.
There are many factors that affect the exchange rates of the currencies. Exchange rate reflects the economic health of country in relation to other countries. Exchange rates are important for both the investors and traders.
Various macro economical factors are studied to predict the future trends and market direction in fundamental analysis. Here are a few fundamental factors that lay an impact on the forex market.
Inflation means higher prices of goods or lower purchasing power of the consumers. The country that has lower inflation rates has higher currency value. While the country that has higher inflation rates has lower currency value. Interest rates increase when the value of a currency falls.
When currencies are being exchanged, the interest rate that is prevalent in both the countries affects the currency value of the currencies. Therefore, one can say that interest rates, inflation rates and exchange rates are related to each other. This correlation that exists among the three rates is examined in the fundamental analysis. Central banks manipulate interest rates to regulate both exchange rates and inflation. Central banks are participants of the forex market and focus on creating an impact on the currency value to stimulate economic growth rate. Higher returns are offered in an economy that has higher interest rates which attract foreign capital. Therefore, the exchange rate of the country also rises. The effect is reversed when the interest rates gets lower.
Balance of trade
The balance of trade between two countries affects the exchange rates. Current account reveals the earnings from money that is invested in foreign land. It also indicates the balance of a trade. When there is a deficit in the current account, this means the country is spending more on imports than it is earning from exports. The country has to borrow capital to make up the deficit of foreign currency that is created. This lowers the country’s exchange rate.
Public debt is the debt owned by the central government. Central government invests in the public sector and finances governmental funding to stimulate the domestic economy. The public or government debt is the least preferred method of financing government operations, as foreign investors find it unattractive. The value of a country’s currency decreases if it has large public debts.
Large debts result in high inflation rates. If a country prints money to pay off the large debt, inflation increases.
Term of trade
A ratio that shows a country’s exports in comparison to the imports is called the term of trade. The term of trade is believed to be favourable, if the exports are greater than the imports. When the demand for a country’s exports is greater, the term of trade also increases. This helps in increasing the currency value of the country.
Political environment of a country is a fundamental factor that decides the fate of its currency. Political stability and support affect the economical performance of a country. Country facing political turmoil will have unstable economy and the currency value will fall. For example, if election results are awaited in a country and the political party which is expected to work towards the economic growth wins, then the currency value of that country will increase.
All of the aforementioned factors are definitely what you need to be aware of if you are looking to trade based off economic factors. Some traders even invite technical analysis in conjunction with the fundamentals in order to craft their own particular strategy. Survey what you think will work best for you and make your move.