What affects Forex – Influences and Factors
Understanding why exchange rates change is key to spotting opportunities as a forex trader. In our market guide, learn what drives forex markets to guide your analysis and trade calls and help you manage risk.
Like any asset class, price movements in the forex market are near-impossible to predict with precision. But learning and studying the key drivers will improve your chances of trading it successfully. Learn what affects forex prices and more below:
What are exchange rates?
Exchange rates tell you how much of one country's currency it takes to buy one unit of another's. This means they're always expressed as pairs; GBP/USD pits the British pound against the US dollar, for example. Read more about different types in our in-depth guide to currency pairs.
Whichever pair you look at, exchange rates are a key indicator of each nation's relative level of economic health. They play important roles in trade, vital to most free-market economies. Between governments, businesses and financial analysts, exchange rates are among the most keenly tracked and analysed economic measures.
They have real implications for investors and traders too. Knowing what impacts currency exchange rates is, in effect, the same as knowing what impacts forex trading.
Why do exchange rates change?
Whether used for buying or investment purposes, the price of one currency relative to another depends on the perceived value of owning it. In this sense, forex prices are primarily driven by supply and demand just like any other financial market.
Investors typically put money into economies with positive outlooks, driving increased demand and raising a currency's value. Conversely, negative news can reduce investment, lowering demand and currency value.
Lots of factors can influence this dynamic, as we've highlighted for you below. These factors are in no particular order, though. Different issues affect different currencies and pairs due to their geography, relationships or other unique characteristics. And their relative importance, like many economic matters, is up for debate.
Economic data
If you want to know what news affects forex, economic data releases are a strong place to start. New information can quickly change the perception of a country's economic health. There are several data points to track, so it's worthwhile maintaining an economic calendar of major releases, as well as monitoring unexpected news.
Gross domestic product (GDP) is an important statistic measuring a country's total output of goods and services. Keep in mind it's a lagging indicator, however, reporting on past events rather than real-time or future trends.
Inflation, the rate of rising prices for goods and services, is also closely tied to economic health. Some inflation can be positive in showing increased demand for goods and services; too much can restrict consumer and business spending power.
If one nation has low inflation compared to another, its currency will usually rise in relative value. Inflation is a key factor dictating interest rates; it's a fine balance that governments and central banks try to manipulate. Read more on the significance of this below.
Other economic indicators with a bearing on current and forecasted performance include employment figures, retail sales and manufacturing indexes.
Capital markets
Global capital markets are another strong, visible indicator of economic health and, therefore, currency value.
Starting with stocks and shares, the performance and dealings of publicly traded businesses are readily available through earnings reports and announcements. If investors move in numbers to buy or sell one nation's foremost securities, this can signal a clear change in the economic outlook.
Many economies are reliant on certain commodity sectors too, creating what are called commodity currencies. Take Canada, which has become a major exporter of oil in recent decades. The Canadian dollar typically has a strong correlation with crude oil as a result, causing their respective prices to move in tandem with each other. What affects forex can affect commodities and vice versa.
Bond markets have relevance too due to the dual reliance of fixed-income securities and currencies on interest rates. Bond yields provide a good indication of the health of a nation's stock market, reflecting demand for its currency.
International trade
Given forex rates show relative demand for two nations' currencies, it makes sense for trade to be another major influence on pricing.
If a country has a trade surplus – i.e. it exports more than it imports and is a net seller – its currency will typically rise in value. International buyers must convert their money into the selling nation's currency, increasing demand and pushing its value upwards.
On the flipside, countries with trade deficits are net buyers who have to sell more of their currency to pay for foreign goods. As major importers, their currencies are likely to be negatively affected. The UK generally imports more than it exports, operating with a trade deficit of £85 billion in 2022.
This dynamic is known as the balance of trade.
Political news
Often closely linked to trade is politics. The political landscape of any nation plays an important role in its economic outlook as well as how it's perceived by outside investors.
Government economic policies, such as sector or industry-specific spending or regulations, naturally carry weight. This can be especially true of new rules affecting investment and trading industries directly.
Political instability or uncertainty perhaps more greatly impacts investor confidence in currency markets, though. Key events to track include close election campaigns, particularly if parties oppose each other on financial policies, and referendums such as the Brexit vote.
More extreme examples include coups and acts of war. The Russian rouble collapsed after Russia invaded Ukraine, which quickly led to economic sanctions.
Central bank policies
Most central banks in developed nations operate independently from governments, as the European Central Bank (ECB) states. The lines can and do blur in some cases. Regardless, their monetary policies and communications, particularly involving interest rates, are keenly watched by forex traders.
As we stated above, interest rates are closely linked to inflation, and both affect forex markets. If an economy is struggling and inflation is below target levels, its central bank may set low interest rates to encourage spending, discourage saving and increase currency demand.
Alternatively, that central bank might raise interest rates if they judge inflation is rising too fast. High interest rates are good for saving, helping attract investors to earn higher returns on their money. This means forex rates can favour currencies of nations with higher interest rates, unless their rate of inflation is significantly higher or other relevant factors are involved.
Market sentiment
Ultimately, supply and demand are primarily driven by investor and trader reactions to all the factors described above. Their shared sentiment is what really affects forex rates.
If traders spot major news in any of the categories we've described above, they will react and trade accordingly. Their behaviour could easily encourage others to do the same, creating trends that shape major price movements. This means both overconfidence and fear can often come into play, making exchange rates somewhat subjective.
Analysing what impacts currency exchange rates
Robust trading analysis can help you study all these indicators and more to justify your trade calls in forex markets. It's commonly broken down into fundamental and technical:
- Fundamental forex analysis looks at the overall state of an economy, including measures such as interest rates, trade and GDP.
- Technical analysis focuses on price charts, seeking to identify patterns and predict future trends.
Fundamental analysis essentially provides the context behind technical analysis. Read our analysis guides to understand how to incorporate them into your trading strategy.
Where to check forex rates
As a trader, the quick and easy way to check forex rates is through our dedicated currency pair market pages. Here you can monitor market sentiment and trends in real-time to guide your next move. Sign up for an account to start trading today.
Up to speed with what drives the forex market? Broaden your knowledge with our other forex trading guides.