International Demand

How are exchange rates set? MintGenie explains

The exchange rates of major countries stimulate international trade and commerce. When a country’s exchange rate rises in the foreign exchange market, its imports tend to be cheaper, and when the exchange rate of its national currency falls, imports become more expensive. It is therefore vital to have a strong and stable currency to get the most out of its goods in international trade. Exchange rates are fixed in two different ways: fixed rate and floating exchange rate.

Fixed exchange rates are those that are fixed against another currency by the government of a country through its central bank. Countries that determine their own currency against the US dollar are Saudi Arabia and China. On the other hand, a floating exchange rate is the currency which is determined by macroeconomic factors, its demand and its supply in the open market.

READ MORE: What is the impact of exchange rate fluctuations on your investments?

Offer and demand

Consistent with traditional economic fundamentals, the exchange rate rises with demand and falls with it. For example, when there is an increased demand for British Pounds (GBP) among US traders and traders, the price of Pounds against the US Dollar (USD) is likely to rise, but of course this will be subject to a range of other geopolitical factors as well.

However, even in floating rates too, countries often intervene to influence their currency to make it suit to their advantage. Additionally, there are dozens of other factors in international trade, currency markets, and the global economy as a whole that influence currency exchange rates.

READ MORE: What is a currency pair and how does it work?

Other factors

There are a multitude of factors that collectively influence the exchange rate of one currency against another. These include inflation, GDP data, changes in interest rates and unemployment. There are a series of short-term factors that influence the exchange rate, such as daily demand and supply, natural or economic disasters and sometimes rumors. For example, when the supply exceeds the demand for the currency, the exchange rate collapses, and when the demand exceeds its supply, the exchange rate jumps.

And in the event of a substantial slip or jump, the central bank tends to step in and buy or sell the currency to curb volatility.

Other key factors that impact the currency’s exchange rate include government stability and geopolitical risks – which speak to the consistency of stable governance in the country and the world around it, impacting the international trade and also the currencies that drive it.

Thus, currency exchange rates are determined by a number of factors including demand and supply, macroeconomic factors, geopolitical stability, interest rates, GDP data, among other reasons.

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