The foreign exchange (FX) market is the largest financial market in the world, with over $6 trillion traded every day. But what actually causes exchange rates to move?
Whether you are sending money abroad, buying a property overseas, or managing international investments, understanding what drives currency values can help you make better decisions.
Who Is Involved in the FX Market?
The FX market is global and decentralised. It does not operate on a single exchange but through a network of banks, brokers, and financial institutions. Here are some of the key players:
- Banks and Dealers: Provide prices and liquidity to the market.
- Brokers: Help clients access the market, often through electronic platforms.
- Businesses: Exchange currencies to pay for imports or receive export revenue
- Investors and Speculators: Trade currencies to try to profit from price movements.
- Central Banks: Manage currency reserves and may intervene to influence rates.
- Money Transfer Companies: Help individuals and businesses send money globally.
What Causes Exchange Rates to Move?
There are many reasons why a currency might rise or fall in value. Some are long-term and based on economic fundamentals. Others are short-term and driven by news, data releases, or market sentiment.
Long-Term Influences
- Interest Rates: Higher rates attract investment, increasing demand for a currency.
- Inflation: High inflation reduces a currency’s purchasing power and can weaken it.
- Trade Balance: Countries with a trade surplus tend to have stronger currencies.
- Public Debt: High levels of debt can lead to inflation or reduce investor confidence.
- Economic Growth: Strong and stable economies attract foreign investment.
- Political Stability: Investors prefer countries with stable governments.
- Central Bank Policy: Central banks trade their own currency to influence its value.
Short-Term Influences
- Economic Data: Reports on inflation, employment, or GDP move markets instantly
- Market Sentiment: Traders react to headlines, forecasts, and global events.
- Technical Factors: Including chart patterns, option expiries, and month-end flows.
Can We Always Explain Price Movements?
Not always. Sometimes prices move for clear reasons, such as a central bank decision. Other times, the cause is less obvious. The FX market is vast and complex, and prices can react to a wide range of factors.
Some theories suggest that prices reflect all available information (the efficient market hypothesis), while others argue that prices move randomly and cannot be predicted (the random walk theory).
In reality, both may be true at different times. For example, the British pound fell sharply after the 2016 EU referendum, not because of a sudden change in value, but due to expectations of future political and economic challenges.
The Bottom Line
Currency values are influenced by a mix of long-term fundamentals and short-term reactions. For individuals and businesses, it is important to focus on your goals and not get distracted by daily fluctuations.
If you are planning a large international payment or managing currency exposure, having a clear strategy can help you avoid surprises and take advantage of opportunities.
Need Help?
At Oku Markets, we help clients understand and manage currency risk. We offer clear guidance, fair pricing, and tailored solutions for individuals and businesses.
Contact us at info@okumarkets.com or call 0203 838 0250 to speak with our team.
Summary
Exchange rates are driven by a combination of economic fundamentals, market sentiment, and technical factors. While long-term trends reflect the strength of a country’s economy, short-term movements can be triggered by news, data, or investor behaviour. Understanding these drivers can help you make more informed decisions when moving money internationally.
Frequently Asked Questions
1. What makes a currency go up or down?
Currencies rise or fall based on supply and demand, which are influenced by interest rates, inflation, trade balances, and investor confidence.
2. Why do exchange rates change every day?
Rates change in real time due to news, economic data, and trading activity. The FX market is open 24 hours a day during the working week.
3. Can central banks control exchange rates?
Central banks can influence exchange rates through interest rate decisions and direct intervention, but they do not have full control.
4. Is it possible to predict currency movements?
Some trends can be anticipated based on economic data, but short-term movements are often unpredictable.
5. How does political news affect exchange rates?
Political events can impact investor confidence and expectations, which in turn affect demand for a currency.
