Factors Affecting the Forex Market

Long-Term Factors Affecting the Forex Market

1. Currency and Credit Conditions

Any economic condition which causes the internal purchasing power of a currency to rise or fall eventually affects its exchange value. Such effects are frequently aggravated by the speculators in the exchange markets. Sometimes these operations curtail or diminish the effects of the economic factors.

An expansion of currency circulation in a country raises the level of internal prices, or in other words, reduces the purchasing power of the currency and in the country. This has an adverse effect on export trade of the country and the demand for its currency in the exchange market tends to fall, causing fall in the exchange value of the currency. The speculators then sell the currency with the intention of buying it   back when its price has gone down. This has a further lowering effect on the exchange value. This trend prevails till the effect of the internal rise in prices on exports is offset by the fall in the exchange value of the currency. A revival of a trade activity or an improvement in the investment climate in a country increases the demand for the country’s exports from rising further.

A currency may be in demand as it may be used as reserve by central banks or is used for making internal payments. This is usually a currency which is easily convertible into other currencies. U.S. dollar is one such currency and its value could be maintained in spite of large supplies of dollars in the world market. British sterling has been convertible into other Sterling Area currencies and has been in use for payments between countries of that area. Since 1958, the sterling has been made initially convertible into other currencies also and its demand has increased. This, therefore, been able to maintain its value in spite of payments deficits.

2. Political and Economic Conditions

Political conditions in a country have an effect on the exchange market. A stable government and healthy economic and political conditions are factors which entourage foreign capital to flow into the country. The demand for the country’s currency strengthens its exchange value. Political unrest, on the other hand, causes and outflow of capital, weakening the currency externally.

The current position and future outlook in the industrial field, the budgetary position of the government, and an overall economic situation have also important influences in the exchange market. The existence of industrial peace, stable level of wages and prices and high level of efficiency in production have a strengthening effect on the exchange value of the currency in the long period. Similar is the effect of a balanced budged. Conversely, industrial unrest, high cost of production and prolonged deficit financing having an adverse effect on the exchange value of the currency.

The effects of economic and political factors on exchange rates are further accentuated by speculation. Speculation creates considerable uncertainty and disturbance in the exchange market.

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