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The exchange rate: how it is determined, who influences it, and what to focus on

The exchange rate: how it is determined, who influences it, and what to focus on
A breakdown of the exchange rate, how it functions and what affects it
The dynamics of exchange rate quotations can sometimes be difficult to track. Indicators fluctuate many times during one day. If at the time of the opening of the exchange, the exchange rate will take one value, then by the time of closing, it can change the vector and change both in the positive and negative sides. This state of affairs makes it necessary to monitor the changes between the two national monetary units, and you can conveniently do this on Finance - Rates.
Exchange rate platform
Around the world, currencies are traded for a variety of purposes and via a variety of channels. The US dollar, the euro, the Canadian dollar, and the British pound are just a few of the main currencies that are often exchanged internationally. With almost 87% of all international transactions taking place in US dollars, this currency is renowned for dominating all other currencies.

How is the market rate of currencies determined?

The exchange rate is formed due to the supply and demand for one currency in relation to another. How the exchange rate is formed can be explained using the example of the most familiar currency pair for us, the hryvnia, cash flow is 688 billion hryvnias, to the dollar.
On the one hand, there is a constant inflow of foreign currency to Ukraine: metallurgists, farmers and other exporters sell their products abroad, the country receives funds from external creditors, and Ukrainians working abroad send money to their families by bank accounts using VISA, because Visa cards are accepted in 200 countries, and so on. To use this currency in Ukraine, it is exchanged for hryvnia.
On the other hand, Ukraine spends currency by purchasing energy carriers and other imports. In addition, many of our fellow citizens keep their savings in dollars, the country repays foreign loans, and tourists travel abroad. For all this, currency is bought for the hryvnia.

What are the currency exchange regimes?

There are two exchange rate regimes: floating and fixed. Floating has several sub-modes: inflation targeting and monetary aggregate targeting.
The fixed mode is when the National Bank declares a certain exchange rate and makes a small corridor around this declared value of the dollar or euro. The National Bank watches what is happening in the foreign exchange market, but does not intervene until the market rate does not go beyond the corridor established by it. Then the Central Bank begins to supply dollars to the market (becomes on the supply side) or buys back surplus dollars (becomes on the demand side).
However, the inflation targeting system is now in place in the majority of nations, including Ukraine. The currency rate is not set by the central bank. It emphasizes the inflation rate instead. When deciding how much hryvnia should be in circulation, the National Bank bases its decision on the inflation projection rather than the foreign exchange market (although it still keeps a careful eye on what's occurring there).

What can affect exchange rates?

Monetary policy affecting exchange rates

The difference in monetary policy between the two jurisdictions contributes to the fluctuation of their exchange rates. When comparing the monetary policies of any two jurisdictions, a number of factors must be considered.
  • Inflation: Exchange rates are basically the ratio of units of one currency to units of another currency. Suppose inflation in one currency is 7%, and in another - 2.5%, any adjustments in the level of inflation will affect the exchange rate. Inflation rates have a significant impact on exchange rates, but they don't always reflect the whole situation. Market participants can also use their own estimates of inflation to estimate the exchange rate.
  • Interest rates: When investors invest in a particular economy, they earn a return based on the interest rate of the currency they are investing in. Therefore, if an investor holds a currency with a yield of 6% rather than a currency with a yield of 3%, his investment will be more profitable because the interest income will also be factored into the market exchange rates. Therefore, any adjustment in interest rates will have a significant impact on the value of the currency. It only takes a small adjustment in interest rates by the central bank to trigger a strong market reaction.

Fiscal policy affecting exchange rates

While monetary policy is managed by the country's central bank, fiscal policy is regulated by the government. Fiscal policy is important because it predicts future changes in monetary policy.
  • Shortage of public funds: The government of a country with high public debt is responsible for large amounts of interest payments. Debt and interest can be paid from his taxes, that is, from the available money supply. Otherwise, the country will monetize its debt by printing more money.
Political Stability: The political stability of a country is also of prime importance to the value of its currency. It is known that the modern monetary system, which is a system of fiat money, is nothing more than a promise by the government. Thus, in times of political unrest, there is a danger that the promises of the current government may be nullified if a new government comes to power. Surprisingly, a future government may decide to issue its own currency as a way of asserting its power. For this reason, whenever a country is affected by geopolitical upheaval, there is usually a sudden drop in the value of its currency relative to other currencies.

How does the exchange rate affect our finances?

Inflation is determined according to the value of the consumer basket (a set of goods and services consumed by a representative urban consumer during the year). Most of this basket is imported goods.
If the hryvnia begins to fall, the cost of imported goods increases. Since they make up a large part of the consumer basket, their value increases and inflation begins.
If the hryvnia strengthens, imported goods conditionally become cheaper. But there is one interesting economic phenomenon: prices like to rise, but they don't like to fall. Therefore, we will practically not notice a decrease in the price of goods.
The currency rate and inflation rate are directly related in this way. However, a 1:1 correlation between these two ideas is not possible, because domestically produced items begin to replace imported ones, which causes their value to begin to increase once more. Devaluation, however, unquestionably affects businesses with growing inflation.
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