Barclays

Factors that affect currency rates

Exchange rates continuously fluctuate, there are several factors such as interest rate expectations, inflation, macro economic risks and events.

Short-term factors

• Interest rates: a government may decide to lower interest rates in an attempt to stimulate growth in the economy. Generally, this means that investment funds will flow out of one currency into another currency that has higher interest rates. So when looked at in isolation, lower interest rates could weaken the currency.
• Trade flows: a trade surplus is where there is a greater demand for goods and services from a country, which means its currency (needed to pay for those goods) will be stronger. Conversely, a trade deficit will usually weaken the currency.
• Natural disasters: think about the earthquakes in Japan and New Zealand and the effect this has had on their currencies. The currencies initially weakened on the events due to the unknown damage made to the economy. They then strengthened as insurance funds and other sources of funding flowed back to these countries from overseas to fund the repairs. Then the currencies weakened due to action taken by their central banks to aid economic recovery, such as injecting additional funding into the financial market and reducing interest rates, had a negative impact on the currency.
• Economic growth: an investor may choose to hold one currency over another simply because that country is growing at a faster pace than the other or is perceived to do so in the future.
• Links to commodity based currencies: currencies such as Norwegian Krone or Canadian dollar are commodity linked currencies and their exchange rates tend to increase in value when there is a rise in commodities such as oil.
• Conflict: there may be a period of time where there is no official government in place or when a person or organisation has taken power illegally. This will naturally have an effect on the currency and will be ongoing as the conflict continues.
• Short term inflation: if inflation is starting to rise then the natural response for the authorities will be to limit the rise of inflation by increasing interest rates, therefore clients may convert into that currency in anticipation of gaining a better return on their money.

Long-term factors

• Long term inflation: this is a rise in the general level of the prices of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services. Consequently, inflation wears away the purchasing power of money in that country. So higher inflation in a country typically weakens its currency.
• Economic growth: it can take many years for an economy to recover i.e. the subprime crisis in the US took place over three years ago, and it has taken many years for the US economy to recover to the level it's currently at.

You can see how varied and far-reaching these factors are. This is why trying to make a prediction is difficult, especially as sometimes it is the uncertain or unexpected events that cause the most volatility in a currency. So if you're risk averse, it's well worth considering how you can reduce currency exchange rate risk.

Find out more

If you are not currently a Barclays International client, but are interested in our FX services you will first need to apply for our banking services, which you can do by calling +44 (0)1624 684498^† or accessing our online application by pressing the button below.

If you are an existing client and would like to find out more information please either contact your Relationship Manager, call us on +44 (0)1624 684498^† or complete a call back request form.

Please note: access to our Treasury Specialists is via a three-way conference call. Clients who do not have a Relationship Manager and require a call with a Treasury Specialist or want to conduct a FX forward should either:

• Hold assets of £50,000 with us, or
• Intend to transact a minimum £50k (or currency equivalent)