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Everything you need to know about exchange rate fluctuations

Picture the scene. You’re all set to make a transfer and then for whatever reason, you get distracted. No worries, you think. You’ll come back to that tomorrow. But when you do, you notice that the exchange rate has fluctuated and the cost of your transfer is now higher (boo!) or lower (yay!).

So, why is the exchange rate in constant flux? And hang on, what even are exchange rates?

To put it simply, the exchange rate is the value of one currency that can be converted to another. It is considered an important determinant of a country’s relative level of economic health. And many factors can influence them—from supply and demand to inflation and interest rates. 

Here are 3 (broad) factors that cause exchange rate fluctuations.

Inflation and interest rates

Inflation refers to the rising prices of goods and services within an economy over time. Meanwhile, interest rates reflect the amount of interest due based on the amount lent, deposited or borrowed. 

Countries with consistently lower inflation rates tend to see an appreciation of their currency’s value. This is because its purchasing power rises in relation to other currencies. In contrast, higher inflation rates lead to higher interest rates and currency depreciation. Both inflation and interest rates are highly correlated, with either serving as an indicator for the country’s current and forecasted economic performance.

Central banks can manipulate interest rates to exert influence over both inflation and exchange rates. When interest rates are higher, lenders are offered a higher return in relation to other countries (meanwhile attracting foreign capital). This, in turn, can cause a rise in exchange rates. Meanwhile, falling interest rates tend to lead to decreasing exchange rates. 

Supply and demand

The economics of supply and demand state that the value of something decreases when there’s an excessive supply. In contrast, when demand is high and supply is low, its value rises. This, in turn, leads to price increases and currency appreciation.

Many factors can affect supply and demand including government intervention and speculation. For example, when a country wants to increase the exportation of products, its government may intervene in the currency markets. This has the effect of making the country more competitive within its market. Meanwhile, speculation of investors around a country’s currency value rising increases demand. With this increase also comes a rise in the currency’s value and thus, the exchange rate. 

Government debt and political stability

If a country’s central government is in public or national debt, it’s less likely to attract foreign capital. This in turn leads to inflation. As a result, investors may choose to sell their bonds in the open market based on predictions, leading to a decrease in the exchange rate. 

Likewise, if a country is experiencing a recession, its interest rates are likely to fall; meanwhile decreasing its chances of acquiring foreign capital. This again weakens the value of its currency and causes a decrease in the exchange rate. 

The chance of a country acquiring foreign capital also decreases if it is experiencing political or economic uncertainty. Events like these can spur investors to cash in their assets. As a result, the country sees a depreciation in the value of its domestic currency. A good example of the effect of political upheaval on exchange rates is Brexit. After the referendum in 2016 (and the months and years that followed), the pound sterling experienced a sharp decline.

How does TransferGo set exchange rates?

Here at TransferGo, we’re 100% transparent about our low fees and (very) competitive exchange rates. Our exchange rates are also fixed so that the amount you decide to send is what will arrive. Once you’ve sent a transfer, you won’t need to worry about exchange rate fluctuations. We include all of our fees in the final amount so you won’t have to worry about hidden costs either. Happy days.

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And if you want low fees and competitive exchange rates, TransferGo is here. Sign up now to send money at high speeds and low fees.

2021-03-12

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