There are various factors that determine an exchange rate. Trade value, inflation, and interest rates, to name a few. These are basic principles to help understand the concept. Increased demand for a currency is due to either an increased transaction demand for money, or an increased speculative demand for money. The transaction demand for money is highly correlated to the country’s level of business activity, gross domestic product (GDP), and employment levels. The more people there are out of work, the less the public as a whole will spend on goods and services. Central banks typically have little difficulty adjusting the available money supply to accommodate changes in the demand for money due to business transactions.
Interest rates are determined normally by a Reserve Bank governor that determines economic policy for a currency. Interest rates can also be manipulated to stimulate an economy by strengthening or weakening a currency. Read the rest of this entry