Why Currency Values Fluctuates
What causes the fluctuations in the currency values? Basically the fluctuations are caused by the demand and supply of the currency. The demand and supply is generally affected by a country's trade and its macroeconomy policies.
Interest Rates
When the interest rates of a country is high, investors and speculators will take advantage of the higher interest rates. Money will flow into the country. This will boost the demand for the country's currency and can cause the currency to appreciate.
Money Supply and Inflation
When central banks prints money, money supply will increase. There will be more money in circulation. Inflation goes up, the currency value becomes weaker and this causes the currency to depreciate.
Balance of Trade
When a country exports more than it imports, the country is known to be in a trade surplus. Demand for its currency usually follows and this causes the currency to appreciate.
Economic Growth
When a country anticipates weakening economy, investors will cash out their investments and transfer their money to other countries with higher growth prospects. Demand for the currency falls and the currency will depreciate. This is evident in the recent financial crisis in Oct 2008. The Euro and GBP depreciated as investors cash out to buy US Treasury bonds.
Market Speculators
Speculators will sell currencies they anticipate will weaken, and buy currencies they anticipate will strengthen. Central banks have limited foreign reserves and if the volume sold and bought by speculators is huge, even central banks cannot do much to stabilize their currencies. This is evident in the 1997 Asian financial crisis whereby speculators short Asian currencies, causing these currencies to devalue.
Foreign Debt
Many nations, especially the developing and under developed nations, are fond of getting loans from developed nations and international funding sources like IMF and World Bank. This money is immediately added to the balance of payment of the borrowing nation. This will lower the currency value of the borrowing nation. The currencies of the under developed and developing nations always go down because of this unplanned borrowing. African, Caribbean and South eastern nations are good example of this scenario.