What Are The 4 Main Factors Affecting Foreign Exchange?

Peter Lavelle at foreign exchange specialist Pure FX

In this post I’d like to share with you the four biggest factors impacting the foreign exchange rate. The idea is, once you have a handle on these influences, you’ll be in a better position to look at what’s happening in foreign exchange, and decide if now’s the right time for you to change currencies.

In a nutshell, the 4 biggest influences on the foreign exchange rate are:

1. Politics.
2. Economic data.
3. Acts of God.
4. Terrorism.

Each of these factors has an important influence on the state of our planet. For instance, if no one’s sure who’ll be President of the United States in 2013, and the US remains the biggest economic and military power on the planet, then the politics of the US presidential race have a big impact on the exchange rates.

In the same way, if the Eurozone economy contracts –0.3% one quarter, that has a big impact on the global outlook, which will impact the euro against other currencies. Hence, exchange rates change according to national and international developments, and their potential consequences.

Let’s look at each of these 4 factors in more detail then.

1. Politics. Politics matters because politicians decide to a large extent where their countries are going. The strength of a currency reflects to a greater or lesser extent the strength of the nation. Hence, if a politician makes a bad decision, or announces a policy that might weaken their country, that’s likely to damage the value of their currency. For instance, if Barack Obama decided to ignore the US debt problem, that might cause markets to worry. That might in turn damage the dollar then.

2. Economics. Economics can be seen to some extent as a measure of the effectiveness of a politician’s policy. If for instance George Osborne decides to cut UK public spending and the UK economy stops growing, that can be seen as an indication of the effectiveness of his policies. That in turn would weaken the UK outlook of course, and cause the pound to weaken. Conversely, if the UK starts to expand at a rapid pace because of Mr. Osborne’s approach, the pound would rise.

3. Acts of God. By this I mean things like natural disasters, rather than miracles per se. Disasters tend to have an adverse effect on national economies, which in turn causes their currencies to weaken. For instance, the earthquakes in Christchurch (in New Zealand) in 2011 caused widespread damage, prompting an immediate dip in the NZD.

4. Terrorism. Terrorist acts (like acts of God) cause widespread damage and panic, causing the currency of a nation to lose value.

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