Factors Affecting Forex Exchange Rates.

In a perfect forex market, the forex exchange rates would only be affected by the market forces of demand and supply. In this case increased demand for a particular currency would automatically translate to higher forex exchange rates for that currency, whereas decreased demand for the currency would automatically translate into lower exchange rates for the currency is question. We however don't live in a perfect world, and hence there is no perfect forex market. In the real world We live in, forex exchange rates are affected by many other factors, mainly economic and political, besides the market forces of demand and supply.

The other economic factors affecting forex exchange rates, besides the markets forces of demand and supply include inflation patterns and the general state of the economy. Higher inflation rates translate to decreased economic power for the residents of the country in question, which means a poorer state of economy. This in turn translates to lower forex exchange rates for the country's currency. Rising inflation can however cause a paradoxical rise in a country's currency. This is caused by the fact that governments tend to react to rising inflation by rising their interest rates to mop up excess liquidity (money) in the market, which is usually the main cause of rising inflation. Speculators, expecting this reaction, buy more and more forex, hence increasing the demand for forex and decreasing its supply, ultimately raising the forex exchange rates.

The political factors affecting forex exchange rates include government policy and the general political stability or instability of a country. Political stability almost always translates to increased economic activity in the country in question, which in turn generally translates to higher interest rates for its currency. In a similar manner, political instability always translates into decreased economic activity in a country, thereby hurting the country's currency and causing a dip in its forex exchange rates. Other political factors like elections and major political appointments also have an impact on the country's forex exchange rates. The other major political factor affecting forex exchange rates is government policy, which is usually effected through fiscal and monetary tools. Fiscal policy refers to the government's spending, which can affect forex exchange rates because the government is always a major spender in any economy. Monetary policy refers to the governments control over the supply of money in the economy, which the government seeks to regulate from time to time. Ultimately the government has an interest in influencing the forex exchange rates because too strong a currency would hurt the importers, while tool weak a currency would be hurtful to exporters.