Forex is among the most prominent financial markets globally, experiencing tremendous trading volumes daily. The profits traders make on the Forex market come from the volatility of currencies exchange rates.
These are influenced by many factors. Among the most important factors are the country’s economic stability and strength and the key rates defined by the central bank. Let’s dig deeper into the mechanisms of Forex trade and its impact on economies and international trade.
The purpose of the Forex trade
One of the primary purposes is to facilitate the process of international trade. Foreign currency trade enables big institutions and businesses to perform trading operations beyond the border of the country. The dominating currencies in the forex market mean they are more used in international trading agreements and are stronger and more valuable.
The activity of retail traders in the Forex also impacts the prosperity of the market. When the uncertainty in the market arises, the speculators affect the price adjustments, which furthermore impact the profit margins of Forex traders. Individual traders and speculators generally use the services of an online Forex broker to execute their trades. These brokers represent the touch base between the traders and the interbank networks. They provide an adequate trading platform that enables buying and selling of eskort atakoy currencies.
Forex and International Trade
International trade highly affects forex trade as demand for the specific currency determines the benefits of a particular country from the foreign currency market. When countries trade, they agree on the main exchange currency to perform the trade. The chosen currency means an increase in demand for that currency, reflecting an increase in profit for those traders involved in the exchange. The countries with a strong economy whose currency is in high demand get huge revenue from the foreign currency market.
Inflation and exchange rates
Inflation acts directly on exchange rates. Indeed, in a country where inflation intensifies its currency will devalue, and inflation that weakens will strengthen its currency against the currencies of other countries.
For example, if the same basket of goods costs 100 euros in Europe and 120 dollars in the United States, then the equilibrium exchange rate is estimated at 1 euro = 1.2 dollars (we divide 120 by 100).
Thus, the interest rate and inflation affect the exchange rate. However, determining equilibrium exchange rates is not an exact science. It is difficult to estimate the over (or under) valuation of a currency.
The key interest rate
The key interest rates are the short-term interest rates set by central banks. The latter use them to steer their monetary policy. Consequently, it will also control the money supply and regulate the economic activity of their country.
By setting the rate, the central bank acts on the exchange market. And, therefore, it affects the competitiveness of a country or a zone.
For instance, if the European Central Bank (ECB) chooses to raise its key rate, foreign investors should be encouraged to have liquidity in Euro to make investments in this currency. This increase in demand for the Euro appreciates this currency on the foreign exchange market. So, in theory, there is a positive correlation between the exchange rate and the key interest rate.