There’s no guaranteed way to predict the movements of a particularly currency, or in fact any currency in the world.
It’s impossible to tell whether the US dollar is actually going to go up or down against the euro, or whether the Chinese yuan is going to appreciate against the British pound – but there are ways to look out for what might happen. Here’s how...
The first one is simple: the value of a particular country’s currency is often tied in with its interest rates. Basically, higher interest rates are a good indication that people are more inclined to save money in that country, as they will get a bigger return on their savings. This brings in an inflow of money, as it’s more attractive, which leads to a rising of the exchange rate, known as appreciation.
Following on from interest rates is the link to economic growth. Put simply, the stronger a country’s economy, the higher the interest and participation in that country’s marketplace will be. This leads to higher demand for that country’s currency, which leads to an increase in that currency’s exchange rate. In other words, if a country is performing strongly economically, inflation rises and so too does the value of its currency.
Another factor to consider is speculation, which becomes somewhat of a self-fulfilling prophecy all by itself. Basically, when people begin to predict that the price of a currency will increase, they start to buy more of it, and actually increase demand for it themselves. A good example of speculation is the US dollar, which became weak in 2007 due to falling interest rates, and continued to fall even further beyond expectations because of the speculation itself that it was falling.
Long Term Competitiveness and the Big Mac index
It has been argued that the long term exchange rates will change to equalize differences in their purchasing power. A theory known as the Big Mac index shows the local price in US dollars of buying a McDonalds Big Mac in various countries around the world. The theory goes that in the countries where the Big Mac is very expensive, the exchange rate is overvalued. The theory continues that this exchange rate should fall in the long run, equalizing the purchasing power of these currencies.