The fundamental factors

Indicators

Economic indicators are fragments of economic and financial data, published by governmental and private agencies. These statistics help us to monitor the entities that control the market and react to its simplest changes. In order to respond to economic publications properly, it is necessary to understand the relationship between the statistical reports and the exchange rates of the currencies in question. We would now like to present the most influential economic indicators and define their impact on currency prices.

Output indicators: GDP, industrial production, retail sales. Any increase in data releases tells us that the economy is growing. If releases are strong, look for currency appreciation. Sentiment indicators: business and consumer sentiment. This group of indicators serves as a barometer of the mood of consumers or investors. The more spending/investment, the stronger the domestic economy and currency. Labour market indicators: payrolls, employment/unemployment change, unemployment rate, jobless claims. The higher the employment rate, the better for the domestic currency (the opposite with unemployment). Housing market indicators: building approvals/authorisations/permits, new/existing/pending housing sales. If there is a sign of increased economic activity in the housing market, it means that the national economy is healthy. This causes the exchange rate of the nation’s currency to rise. Inflation: PPI, CPI, GDP, RPI. Rising inflation is negative for the national currency, while lower inflation is positive. In the short term, however, CPI and other inflation indices can have the opposite effect on the currency. Significant increases in inflation indicators may push the central bank to raise its interest rate. This may cause the exchange rate of the currency to rise. Trade balance: the total value of the country’s exports minus the total value of its imports; >0 means surplus <0 means deficit. When a country has a trade surplus, demand for its currency increases from foreign buyers, so the domestic currency appreciates. Conversely, a trade deficit causes the nation’s currency to depreciate. The current account balance: balance between a country and its trading partners, reflecting all payments for goods, services, interest and dividends; >0 means surplus <0 means deficit. A deficit means that the country is spending more than it earns and is borrowing from abroad to reduce the deficit. The impact on the domestic currency is negative. A surplus, on the other hand, has a positive impact on the currency.

Monetary policies of central banks

Interest rates. All major central banks set their key refinancing rate. There are two types of monetary policy: easing (low interest rate if the domestic economy needs a boost; currency impact is negative) and tightening (raises interest rate to curb the rising inflation rate; currency impact is positive).

Bond purchases. Sometimes central banks resort to massive purchases of government bonds in order to increase the amount of money in circulation, in doing so they try to make credit cheaper and boost economic growth. These unconventional monetary measures lead to currency depreciation. Central bank bond purchases that lead to increased money supply are known as Quantitative Easing (QE).

Government fiscal health

Budget balance and debt. If a country is head over ears in debt, it is less attractive to foreign investors, because large public debts lead to inflation. In addition, large debt can be worrying for foreigners if they believe that the country is at risk of defaulting on its obligations. In this case, demand for the currency will decrease and its exchange rate will fall.

News flow

-Political, social and other news. -Economic forecasts by the IMF, OECR, World Bank and other organisations. -Changes in sovereign credit ratings by Moody’s, Fitch, S&P and other agencies. Foreign investors tend to look for politically and economically stable countries. That is why recurrent news of political turmoil or unrest causes investment outflows from the affected country. As a result, their national currency depreciates due to the outflow of foreign investments. Sometimes even politically stable countries experience social unrest, government reshuffles and major legislative changes. All these events can also influence the currency. Unexpected election or referendum results can cause volatility in major currencies (remember the effect of Trump’s victory or the consequences of the Brexit vote). Political statements by national leaders, public acts by central bank governors can cause currency prices to fluctuate.

Considerable changes in the currency exchange rate can also be caused by news flow of a different type. We are talking about economic forecasts by such financial institutions as the IMF, OECR, World Bank, or changes in sovereign credit ratings by Moody’s, Fitch, S&P and other agencies. Finally, some truly unexpected events, such as earthquakes and other natural disasters. These events are destructive for economies and consequently for exchange rates. However, the relationship is not always straightforward. For example, in 2011 the Japanese Yen actually strengthened after an earthquake in Japan: the reason was that investors perceived the Yen as a safe haven currency and it kept rising over time, even when the market’s appetite for risk was sinking.