Supply and demand
Exchange rates for forex pairs are based on the supply and demand of one currency versus another. In basic terms, if demand for one currency is greater than another then the price of the first currency will rise against the second.
The below factors all feed into what influences supply and demand.
Central banks
A currency’s supply is controlled by central banks, who can announce measures that will have a significant effect on that currency’s price.
Central banks choose whether to increase or decrease interest rates. Typically when a country chooses to raise interest rates, the country’s currency may increase in value. This is because it attracts foreign investors who want to benefit from the higher interest rates.
Quantitative easing, meanwhile, involves injecting more money into an economy, and can cause a currency’s price to fall in line with an increased supply.
Interest rates and carry trades
One of the more popular investments among institutional investors is called a carry trade – based on interest rate differentials between countries.
This involves selling a currency with a low interest rate, with the goal of using the proceeds to buy a currency with a higher interest rate. This aims to capture the difference between the rates.
