This section explains exchange rates and how the economic principle of supply and demand influences them

Fundamental Factors

Supply and Demand

Prices of goods, commodities and exchange rates are determined under the control of two forces, supply and demand.

The laws of supply and demand show that:

  • High supply causes low prices, and high demand causes high prices.
  • When there is an abundant supply of a given commodity then the price should fall.
  • When there is a scarce supply of a given commodity then the price should increase. Therefore, an increase in the demand for a commodity would cause it to appreciate in value, whereas an increase in supply would cause it to depreciate.

Interest Rates Importance to Forex

Interest rates play the most important role in moving the prices of currencies in the foreign exchange market. Since currencies represent the economy of a given country, differences in interest rates affect the relative worth of currencies in relation to one another. When central banks change interest rates they cause the forex market to experience movement and volatility.

How Interest Rates Play a Role in the Currency Markets

An increase in interest rates encourages traders to invest within that market and causes the demand for the currency to increase. When there is a demand, the currency becomes rarer and consequently more valuable. Investors are drawn to the currency, because they will gain a higher yield on their investments. In order to purchase the country’s assets, traders will have to convert their domestic currency to the target country’s currency, which also leads to an increase in demand.
