Why Currency Rates Fluctuate
A currency without a fixed exchange rate will fluctuate. Fluctuation involves a change in the value of the currency in comparison to other currencies. A drop in the value of the Euro decreases the number of dollars necessary to purchase a Euro, just as an increase in the value of the dollar increases the number of Euros it can purchase.
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Acquisitions
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Currency rates fluctuate because a company needs a foreign currency for a purchase. A British company may need a billion Australian dollars to purchase an Australian company. This means that the British company has to sell many British pounds and purchase Australian dollars, which reduces the value of the British pound and increases the value of the Australian dollar.
Interest Rate
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Interest rates affect the exchange rates of currencies. A Japanese investor may not receive interest because yen accounts in Japanese banks do not pay any interest. If an account in New Zealand dollars pays 7 percent interest, this is an incentive to sell the Japanese yen and open a savings account in New Zealand dollars. Since an increase in the interest rate raises the return of a savings account, a decision by a nation's central bank to raise the interest rate will increase the value of its currency.
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Reserve Currency
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A currency may be the reserve currency for the world. According to the United States Treasury, the United States dollar is currently considered to be a reserve currency. This means that the United States dollar is viewed as safer than other nations' currencies, so an unexpected disaster that reduces the value of other investments, such as stocks, leads to people purchasing United States dollars to safely hold their money.
Central Bank Intervention
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The central bank of a nation can intentionally change the exchange rate of its currency. A country that depends on exports may lower the value of its currency so it can sell cheap goods to other countries and capture a larger share of the market. Although businesses in the country receive a lower amount of foreign currency for each individual sale, the market share that their products gain can provide exporters with a greater overall income.
Commodity Prices
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Commodity prices affect currency exchange rates. A country that has reserves of oil, gold or other valuable products can sell these assets to purchase foreign currencies. This makes it safer to hold the currency of that country. A country that owns large quantities of oil, such as Saudi Arabia or Norway, has the option of selling the oil to pay its foreign debts instead of printing money which will weaken its currency.
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References
- Photo Credit euro image by Einar Bog from Fotolia.com
