Causes of Exchange Rate Fluctuations



The rate of exchange between different currencies will vary, almost every day.  The following reasons enable to describe the fluctuation.  The possible causes for fluctuation of exchange rate are changes in the demand for and the supply of a currency on the foreign exchange market.  All the following factors that cause a change in demand or supply and cause either a shortage or a surplus, which in turn cause fluctuation of exchange rates.  The factors are 1) Changes in the balance of trade in goods and services 2) Inflation 3) Changes in interest rates 4) The price of oil 5) Speculation 
1) Changes in the balance of trade in goods and services are the most important factor for exchange rate fluctuation. When imports are greater than exports causes a current account deficit, which causes less demand for the currency by foreigners. Less demand causes a fall in price of the currency.  The effect will be just opposite if there is a current account surplus.  
2) If the rate of inflation is very high than that of other countries, the price of goods will rise faster than foreign prices. This will cause a fall in demand for goods in foreign countries. This will cause a reduction in export and hence a fall in the value of currency.
3) If the rate of interest in a country is very high, the foreigners are interested to save money in that country’s banks and financial institutions. This will increase the demand for that country’s currency and hence a rise in the value of their currency.  
4) Oil is considered as a major source of energy.  Demand for energy made out of oil cause changes in the price of currency. Therefore price of oil is considered as another important aspect.
 5)  Speculation is the process of buying and selling with a view to make profit from a change in price.  Currencies are also bought and sold in the market as a commodity.  Therefore expecting a change in price, speculators trade in currency.  This will also cause fluctuation of exchange rate.
                                                                       Back to Home Page Click here