A floating exchange rate (also called a freely floating exchange rate) is a system in which the exchange rate between a country’s currency and others is determined entirely by market forces of demand and supply in the foreign exchange market, with no government or central bank intervention.

How it works:

• If the demand for a currency rises, its exchange rate appreciates
• If the supply of a currency rises, its exchange rate depreciates
• The equilibrium exchange rate is found where the quantity demanded equals the quantity supplied

Key features:

• Automatic adjustment: Exchange rates adjust to correct balance of payments imbalances without government action
• Volatility: Rates can fluctuate frequently, sometimes sharply, creating uncertainty for businesses and governments
• No official reserves needed: The central bank does not need to hold foreign currency reserves to defend the rate

Examples of floating currencies: US dollar (largely), British pound, Japanese yen.