Factors causing exchange rate changes are economic and financial variables that shift the demand or supply for a currency in the foreign exchange market. These shifts cause a currency’s floating exchange rate to appreciate (increase in value) or depreciate (decrease in value).

Factors increasing demand for a currency (causing appreciation):

• Higher interest rates: Attract foreign investors looking for better returns, which increases demand for the local currency.
• Rising exports: When foreigners buy more goods from a country, they must buy that country’s currency to pay for them.
• Strong economic growth: A growing economy often attracts foreign business investment.
• Currency speculation: If traders believe a currency will gain value, they buy it to make a profit.
• Confidence: Political stability and sound economic policies attract foreign capital.

Factors increasing supply of a currency (causing depreciation):

• Lower interest rates: Investors may move their money to other countries where returns are higher, increasing the supply of the local currency in global markets.
• Higher inflation: If a country’s prices rise faster than others, its goods become less competitive, often leading to a drop in currency value.
• Rising imports: Buying foreign goods requires exchanging local currency for foreign currency, increasing the supply of the local currency.
• Capital outflows: When residents invest their money in foreign countries, they sell their local currency.
• Political instability: Uncertainty leads investors to sell their assets and move capital elsewhere.

Purchasing Power Parity (PPP): This theory suggests that in the long run, exchange rates adjust so that the same basket of goods costs the same in different countries. If a country has high inflation, its currency will typically lose value over time compared to countries with stable prices.