The theoretical level
Exports and imports
Import increases compared with the export depending on how the price and the cost of production in the state exceed the same performance abroad. Thus, the high price of the currency of foreign states is formed from the fact that domestic prices are high, and in the international market, in contrast, is low. This factor, which was of great importance in the 20 years of XX century, is called the "purchasing power parity" of the exchange rates. According to this parity, the ratio of exchange rates between the two states varies proportionally on how changes the relationship between prices in the international market and prices within the country.
The price of a foreign currency is growing along with the desire of the population of the state to buy foreign goods and services of foreign companies and firms. At the same time, the demand for import products increases depending on the growth of national income. In such a situation there is a tendency to the fact that the foreign currency depreciates. Such processes are due to the tendency of states to the import: the higher national income of the country, the wider becomes the import at the same level with the growth in domestic consumption.
Movement of capital
The investors can also fill the price of a foreign currency, if they desire to get as much stocks, bonds, debentures, bank deposits and cash in the money supply of foreign states. If a certain state,on the contrary, receives payments from foreign governments - it reinforces its national currency.
This factor that determines the movement of capital is closely associated with currency speculation. Foreign exchange rates would behave sluggishly and not committed to serious fluctuationsif it was based exclusivelyon payments or export of goods. But if the euro exchange rate falls from 1.04 to 0.97 dollars per euro, there are serious fears that the fall will be much bigger. The owners make efforts to get rid of the euro. The sales of euro are rising and the demand for it is reduced, as there is short-term speculative capital flow, which further reduces the rate of the euro currency. If the outflow of capital goes only in one direction or its volume increases dramatically, this could cause sudden changes in exchange rates and even lead to a financial crisis.
The practical level
Expectation and Publication of data
“Data” is an umbrella term that can include such events as: the publication of economic indicators of the countries whose currencies are traded; information that these countries changed the rates; reviews on the state of the economy, as well as other events that significantly affect the exchange market.
The strongest engine in exchange rates is the expectation of an event and its happening. It is difficult to determine what influences the market more - waiting for an event, or the event itself.
Important data can include: Nonfarm payrolls, GDP, Industrial production, CPI, PPI, and others.
For each indicator, there is known in advance the date and times of its release. The market is preparing for such events. Based on the value of the publication of a particular indicator and its probable interpretation, there are generated forecasts and expectations.
Exchange rates can suddenly swing after the data appearance. The movement of the rate in one direction or another depends on the interpretation of market participants of different indicators. Due to exchange rate movements, the trend that already exists can increase, or there can appeara new one.
The movement in a certain direction begins before the publishing of the information about the event - that is, market prepares for the event. Based on this, the already published data (if expectations coincide with the published information) causes a movement in the opposite direction of the course. It comes from the fact that the positions that were open on expectations events are closed as there is a "profit taking".
Fund Activities
Due to the force of their impact on long-term movements in exchange rates, the funds are very important and influential on the Forex market (these can be pension, investment, insurance and hedge funds). Among other things, funds are also involved in investing in certain currencies. With its considerable resources, funds can cause foreign exchange rates to move in a certain direction. Assets of the fund are managed by real professionals – the fund managers.
The activities of exporters and importers
Exporters and importers appear as users of the exchange market (market users) in pure form. The importers have an interest to buy the currency, while the exporters are interested to sell it. Reputable firms hold analytical departments that conduct export-import operations, specializing in forecasting exchange rates, to have a greater or lesser benefit in making a purchase or a sale of foreign currency of particular countries.
The quotes from politicians
Another influential factor are the statements that may have an impact on exchange rate movements that are born during public speeches, reports, participation in meetings of politicians, press conferences, summits (such as the summit of the Group of Seven).
The presentations of the political figures are monitored in real-time by tenacious reporters from news agencies (such as Bloomberg and Reuters). Once the statement appears, journalists stick it in the news column of its agency (the so-called "hot lines" or "hot news"). Such statements can be so powerful that these are comparable in their effect with indicators.
The central banks
The influence of governments on the currency market happens via the central banks. If the central bank of the state has no influence in currency exchange operations through the purchase/sale of foreign currencies on the international currency market, it means the currency is in the "free floating", which is a rare phenomenon.
The countries are forced to adjust the exchange rate to ensure the growth of consumption and production development. Usually regulation can be direct and indirect. Indirectly, the exchange rate is adjusted by the amount of money in circulation and inflation. Directregulation is made throughcurrency interventions in the foreign markets and discount policy. Currency interventions are accompanied by a sharp discharge or withdrawal of the large amounts of the currency from the international market. The Central Bank enters the market, taking advantage of the commercial banks. Interventions lead to large movements in exchange rates, as these are implemented in the amounts of billions of dollars.