Why Do Exchange Rates Fluctuate?


Quick Answer

Exchange rates for currencies fluctuate primarily due to supply and demand for the currency for each nation. The main factors behind the supply and demand for a particular currency are the political stability of a nation, its economic stability and the interest level investors have in holding a country's currency.

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Full Answer

As a nation becomes more politically stable, its money supply is less likely to experience disruptions, continuing to maintain its value. This makes it safe to hold on to the currency, which reduces market volatility in the currency. Eventually, demand rises for the stable currency, which leads to a rise in the price of the currency. If the political situation is unstable, however, demand for the currency falls while the supply for it raises as investors disinvest in the currency. This causes the currency to fluctuate by falling in price.

Economic stability and strength has much of the same effect on the price fluctuation of currency. As long as an economy is achieving high production rates and low unemployment, there is more demand for the currency, causing investors to purchase the currency as a safe haven to hold their money in. This leads to a shortage of the supply of the currency, eventually raising its price. When there is inflation, however, and high unemployment, the demand falls and supply rises, lowering the value of the currency.

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