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Exchange rates explained
A currency's value reflects a country's economic and political stability.
Exchange rates are the rate at which one country’s currency is traded for another. And they fluctuate with the market. But how rates are calculated and what affects them ultimately depends on the mid-market rate, interest rates and the overall stability of a country.
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The mid-market rate
The mid-market rate is the midpoint between the buy and sell prices, or the demand and supply for a currency. This is the best rate you could possibly get, and it’s what you’d get if a company really charged you no fees and a 0% commission.
Traders on the world’s markets buy currencies at the mid-market rate and then sell them at a markup to turn a profit.
Our graph shows the fluctuations of the US dollar against the euro, set by rates buyers and sellers are offering on the foreign exchange market.
What influences foreign exchange rates?
Exchange rates are among the ways that experts determine a country’s economic performance. But underlying geopolitical and economic factors, not to mention overall demand, can influence how much a country’s currency is worth.
- Inflation. A low inflation rate can cause a country’s currency to rise in value, because its purchasing power increases in comparison with other countries. If Country A has an inflation rate of 2% and Country B has an inflation rate of 3%, the exchange rate between the two countries will shift so that Country A’s currency becomes more valuable.
- Interest rates. When interest rates go up, currency rates tend to follow. This is because high interest rates attract foreign investors, which in turn increases demand for native currency.
- Public debt. When debt owned by the central government increases, a country becomes less attractive to foreign investors. This happens because large public debt welcomes inflation.
- Terms of trade. If a country imports more than it exports, the value of its currency will depreciate. Because the country is spending more in foreign currency than it’s earning in native currency, the currency supply is greater than the demand.
- Political stability. Investors won’t take the risk of investing in a country experiencing political turmoil and uncertainty, and the value of its currency will fall if investors feel their money is safer elsewhere. For example, after the UK voted to leave the EU, the value of the pound fell dramatically — about 20% against the US dollar.
- Economic stability. When a country enters a recession, interest rates are often decreased to stimulate the economy. This weakens the country’s currency, which depreciates in value. A recession can also cause foreign investors to pull out, further driving down the currency’s value.
- Speculation. Rumors about stability and trade sow the seeds of doubt about a country’s currency, even if nothing’s happened yet. To keep their money safe, investors may pull out of a country, for instance, if they suspect it faces political turmoil or rising inflation.
Quotes from banks and money specialists
Most banks and foreign exchange specialists quote an exchange rate that’s higher than the mid-market rate, sometimes called the interbank rate. Charging a margin on the mid-market rate is how these companies turn a profit on transfers.
By calculating how much foreign currency you’ll receive from a provider compared to the mid-market rate, you can learn how much if a margin you’re paying on the exchange.
|Amount sent in USD||Amount received in EUR|
|Bank of America||$10,000||€8,289|
|XE Money Transfers||$10,000||€8,598|
Rates based on research on January 5, 2019.
Using our chart, you’ll see that you can save about €310 when transferring $10,000 with XE, rather than Bank of America.
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Exchange rates are influenced by demand, socioeconomic and geopolitical factors and what investors think a currency’s worth. While it’s hard to predict exactly what a currency will do, keeping track of the overall economic and political health of a country can help you narrow down the best time to transfer money overseas.
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