What Influences Exchange Rates? 6 Main Drivers

What makes an exchange rate go up or down?

An exchange rate is the price of one currency in another. It moves when demand for one currency changes compared with the other. More people wanting euros, or fewer wanting dollars, pushes EUR/USD up.

So every pair is about two economies. If EUR/USD rises, the euro got stronger against the dollar. That can come from good news in Europe, bad news in the US, or both. Looking at one country only answers half the question.

The Bank of Canada explains how demand for a country's goods and assets moves its floating currency. That is a good starting point, not a formula for guessing tomorrow's price. If base and quote currencies are new to you, read how to read currency pairs first.

How do interest rates affect exchange rates?

Interest rates are usually the first thing traders watch. Each country's central bank sets a key interest rate. If savers can earn more in euros than in dollars, more money may flow into euros, all else being equal.

The key word is relative. The Reserve Bank of Australia explains that rates compared with other countries, and the money that follows them, drive the Australian dollar. A high rate can still come with a falling currency if people fear inflation or trouble ahead.

Markets also look ahead. If a rate rise was expected, it may already be in the price. And if a central bank raises rates but hints that it is done, its currency can even fall.

How do inflation, growth and jobs affect a currency?

Inflation means prices in general are rising, not just one product. Over many years, differences in inflation can affect exchange rates. In the short term, an inflation report matters because it can change what traders expect the central bank to do.

The same headline can tell different stories. Higher inflation with a strong economy and a trusted central bank is one story. Higher inflation while trust in the central bank falls is another. "Inflation is up" is not enough to choose a direction. Note, too, that slower inflation is not the same as falling prices.

Growth and jobs reports work the same way. GDP is the value of everything an economy produces in a period, as the US Bureau of Economic Analysis explains. Read past the headline. A jobs report can show strong hiring but big cuts to the numbers for earlier months. The BLS schedule gives official US release dates.

No single growth rate is healthy for every country. In the US, recessions are dated using many signs, not just two quarters of falling GDP.

How do trade and commodities affect a currency?

An importer may need foreign money to pay its suppliers. An exporter may change its foreign income back into its home currency.

Currency moves change trade, too. If the Swiss franc gets stronger against the euro, Swiss watches can cost more for buyers in Europe. That can hurt Swiss exporters.

Still, a trade deficit, buying more from abroad than you sell, does not predict a fall on any given day. Investment, borrowing and hedging flow through the same market.

Commodity prices matter for countries that export a lot of them. A higher price for a major export can support the Canadian or Australian dollar, all else being equal. But the reason for the price move matters, and so does the other currency in the pair. Oil alone does not explain USD/CAD.

How do politics and fear move currencies?

Elections, government budgets and wars can change what people expect for growth, inflation and trade. No party is always good or bad for a currency. Compare what was announced with what people expected. And tell a headline apart from a policy that actually happens.

When people are scared, investors may rush to cash, cut borrowed bets or protect their foreign assets. The US dollar, the Japanese yen and the Swiss franc are often called safe havens. But no currency is sure to rise in every crisis. Who needs which currency at that moment can matter as much as the story in the news.

Can a central bank fix its exchange rate?

Central banks have tools beyond interest rates. With quantitative easing (QE), a central bank creates new money and uses it to buy bonds. The aim is to push down longer-term interest rates, as the Bank of England explains. The effect on a currency depends on what other central banks do, and on what was expected.

Some countries fix or manage their exchange rate instead of letting it float. A fixed rate can look steady for years. That is not proof it will last.

How can you use this without guessing?

Before a big release, write two short stories. In one, the first currency in the pair rises. In the other, it falls. Note which news would support each one. Afterwards, compare them with what happened, without rewriting your first view.

Next lesson: how to read a forex chart, so you can see how news shows up in prices. Later in the path, how to spot a forex scam explains why anyone who claims to predict this news is a warning sign. To go deeper, read who trades forex, about the banks, firms and funds behind these moves. Then forex market analysis turns your two stories into a plan you can test.