Find the answers to some common questions about foreign exchange (FX) risk, forward contracts, the factors that affect exchange rates and more.
Frequently asked questions
- Why is it difficult to predict currency rate changes?
- What long-term factors affect currency rates?
- What short-term factors affect currency rates?
- How do natural disasters or conflicts affect currency rates?
- How can I make more informed choices about FX transactions?
- How much risk should I take?
- Can Barclays International help me manage the tax and legal side of FX transactions?
Exchange rates are affected by a number of different factors, some long term, others short term. You can examine the various factors in detail and still have difficulty making an accurate prediction. Sometimes uncertain or unexpected events cause volatility in exchange rates.
Long-term inflation: this is a rise in the general level of the prices of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services. Consequently, inflation wears away the purchasing power of money in that country. So higher inflation in a country typically weakens its currency.
Economic performance: it can take many years for an economy to grow or to recover from a shock. For example, the subprime crisis in the US took place over four years ago, and it’s taken years for the US economy to recover to its current level.
Interest rates: a government may decide to lower interest rates in an attempt to stimulate growth in the economy. Generally, this means that investment funds will flow out of that currency and into another that has higher interest rates. So when looked at in isolation, lower interest rates could weaken the currency.
Trade flows: a trade surplus is where there is a greater demand for goods and services from a country, which means its currency (needed to pay for those goods) will be stronger. Conversely, a trade deficit will usually weaken the currency.
Economic growth: an investor may choose to hold one currency over another simply because that country is growing at a faster pace than the other or is perceived to do so in the future. This can lead to increased demand for the country’s currency, and its exchange rates becoming stronger.
Links to commodities: currencies such as Norwegian krone or Canadian dollar are commodity-linked currencies and their exchange rates tend to increase in value when there is a rise in locally produced commodities, such as oil.
Short-term inflation: if inflation is starting to rise, then the natural response for the authorities will be to limit inflation by increasing interest rates. This leads some to convert into that currency in anticipation of gaining a better return on their money.
Natural disasters: after the earthquakes in Japan and New Zealand, those countries’ currencies followed a similar pattern. The currencies initially weakened on the events because of the unknown damage to the economy. They then strengthened as insurance funds and other sources of funding flowed back to these countries from overseas to fund the repairs. The currencies then weakened again as their central banks took action to aid economic recovery by injecting additional funding into the financial market and reducing interest rates.
Conflict: there may be a period of time where there is no official government in place or when a person or organisation has taken power illegally. This will naturally have an effect on the currency and will be ongoing as the conflict continues.
With so many factors in play, there is always some uncertainty as to whether a particular FX transaction could cost you more today than it would tomorrow. But there are some steps you can take to help you make more informed choices. For example, you can get some guidance on the relevant options by speaking with the experienced Barclays International Treasury team or specialists.
This is an important question to answer for yourself before you enter into an FX transaction. The answer depends on your personal risk tolerance and whether you feel the potential rewards are worth the potential loss.
If you don’t know your personal risk tolerance, we can walk you through a process to help you understand your own attitude towards risk. We’ll then work with you to find the most appropriate solutions based on your profile and financial objectives. However, we cannot recommend transactions as being suitable for you. You must make that decision. If you are in doubt, please seek independent advice.
You have sole responsibility for the management of your tax and legal affairs, including making any applicable filings and payments and complying with any applicable laws and regulations. We have not provided and will not provide you with tax or legal advice and recommend that you obtain your own independent tax and legal advice tailored to your individual circumstances.
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