What moves forex markets

Discover six key drivers of currency price volatility.

Forex trading can offer many different benefits to traders – but to make the most of the available opportunities, you first need to learn what moves currency prices. Here are six of the biggest factors behind forex price movement.

Supply and demand

The key driver of forex movement is supply and demand. If demand for a currency – say the US dollar – increases, the rise in people looking to convert their currency into dollars will cause its price to go up, unless supply also rises to match the increased demand.

Similarly, if the supply of money in an economy goes up without a parallel rise in demand, then its currency will drop in value.

While there are five other factors listed here, supply and demand is really the sole driver of forex price volatility. That’s because everything else affects the levels of supply and demand for a currency, which will in turn cause its price to rise or fall.

Central banks

Central banks have the biggest impact on supply and demand levels for the currency that they oversee. That’s chiefly because they can control the base interest rate for an economy.

If you purchase an asset in a currency that has a high interest rate, you may get higher returns. This can make investors flock to a country that has recently raised interest rates, in turn boosting its economy and driving up its currency.

However, higher interest rates can also make borrowing money harder. If money is more expensive to borrow, investing is harder and currencies may weaken.

Central banks can also change the level of money supply. Quantitative easing, for instance, involves increasing the amount of currency in an economy, which will usually cause its value to depreciate.

Find out about how the Bank of England and Federal Reserve affect the markets.

Economic data

Economic data is integral to the price movements of currencies for two reasons – it gives an indication of how an economy is performing, and it offers insight into what its central bank might do next.

Say, for example, that inflation in the eurozone has risen above the 2% level that the European Central Bank (ECB) aims to maintain. The ECB’s main policy tool to combat rising inflation is increasing European interest rates – so traders might start buying the euro in anticipation of rates going up. With more traders wanting euros, EUR/USD could see a rise in price.

One of the reasons that the forex market moves so much is that there’s a large amount of economic data to analyse and trade off. Take a look at our economic calendar to see what’s ahead, and pay particular attention to:

  • Inflation figures
  • GDP
  • Production reports
  • Retail sales
  • Employment

Credit ratings

Investors will try to maximise the return they can get from a market, while minimising their risk. So alongside interest rates and economic data, they might also look at credit ratings when deciding where to invest.

A country’s credit rating is an independent assessment of its likelihood of repaying its debts. A country with a high credit rating is seen as a safer area for investment than one with a low credit rating.

This often comes into particular focus when credit ratings are upgraded and downgraded. A country with an upgraded credit rating can see its currency increase in price, and vice versa.

Sentiment

Market movements aren’t always based on fundamental analysis, and the overall feeling among investors about the direction of an asset’s price movement can be a major influence on forex prices. If the majority of traders back a certain currency to increase in value, for example, it can influence others to follow suit.

Some forex traders will ignore economic data altogether when analysing how to trade – instead looking to identify key trends and patterns, and trade accordingly. This can mean that bear and bull markets build up a head of steam without any economic data to back them up.

You can see sentiment from IG clients – as well as live prices and fundamentals – on our market data pages.

Foreign affairs

Global news stories will often have a major effect on currencies, playing out across the forex markets as traders assess their impact on supply and demand. The announcement of a new construction project in China, for example, could see the US dollar rise if traders anticipate that the United States will be providing materials.

Conflict, too, can lead to forex volatility. At times of increased geopolitical risk, investors will often seek safer places to invest their money – meaning that currencies which are perceived as risky can suffer, and ‘safe havens’ like the Swiss franc and Japanese yen can rally.

Follow the latest forex news here.

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