Factors Determining Exchange Rates
1. Interest Rates- A rate of interest is the price of borrowing money and the reward for saving money. Investors will look around the world to see where the international rates of interest are high or not. If the rates of interest are higher in Australia then investors would all want to place their money into Australian banks in order to receive the highest return. To do this they must effectively BUY Australian dollars. This pushes up demand for the Australian dollar and therefore increases its price (strengthens its currency).
High rates of interest = strong (expensive) currency
Low rates of interest = weak (cheap) currency
2. Fixed or Floating Exchange Rate- Floating (demand and supply) Most exchange rates are described as floating. This means that the currency can change its price based on the demand and supply. Eg. If the demand for a currency increases, its price will also increase.
Fixed (the state chooses) Some countries have used a fixed exchange rate. This is when a government will decide upon a value of its currency and then fix it at that level. This means that £1 will always cost $1.5. It will not change based on demand and supply.
3. Confidence In The Economy- If investors feel confident about the British economy they will be happy to keep their investments in British Pounds. However, if investors do not feel confident about the British economy, they will not want to keep their investments in British pounds because they worry that the pound will lose its value and so their investments will lose their value.Factors which influence how confident investors feel: Any uncertainty about the future of the country, Falling economic growth, Natural disasters, War, Changes in government
Exchange rates, Exports and Imports
Strong Pound Imports Cheap Exports Dear
Weak Pound Imports Dear Exports Cheap