In the global village we all inhabit, in good times and bad, international currency exchange rates remain a constant theme, playing a key role in everyday trade and commerce.
But what are exchange rates really all about, how are they influenced, what determines their value and what commercial impact can all this have when funds are transferred from one country to another?
Exchange Rates - a brief history:
The origins of foreign exchange date back many thousands of years, when traders exchanged goods and services – known as bartering. Some 2500 years ago, the Greeks and Egyptians were trading goods and currencies with molten silver and gold coins.
Later, around the 11th century, the world’s oldest bank, Monte dei Paschi, was created – its sole purpose being to facilitate currency transactions.
The first official forex market was established in Amsterdam, roughly 500 years ago. This was the point from where worldwide forex trading started, providing the possibility for currencies to be freely traded against other currencies. At the same time, it helped to stabilise currency exchange rates.
In 1875, the Gold Standard was introduced, which had the effect of guaranteeing the value of a currency. This prevailed until the end of the First World War, when it became necessary for countries to print more money to finance their expenses.
During the 1920s, the influence of foreign exchange really started to grow, with the Kleinwort banking family gaining recognition as market leaders.
As a successor to the Gold Standard, the Bretton Woods Agreement was introduced in 1944, establishing a system of fixed exchange rates between currencies, with the US dollar becoming the world’s reserve currency.
The modern forex market, as we know it today, was developed in the 1970s and is now the world’s largest financial market.
What are exchange rates?
The exchange rate is how one currency is valued against another. This determines how much of one currency is needed to buy an equivalent amount in a foreign currency.
Today, international exchange rates are regulated by a managed floating exchange rate, whereby each currency’s value is impacted – up or down - by the economic actions of its central bank or government.
What’s known as the ‘spot exchange rate’ reflects the current rate, whilst the ‘forward exchange rate’ is quoted for future transactions.
Each country chooses its own exchange rate regime, which can be floating, pegged (against one or more other currencies) or a hybrid version of both.
What factors influence exchange rates?
There are a number of factors which can alter the short or long-term value of currency. Like all other commodities, currencies are subject to pressures of supply and demand.
Interest Rates - Demand can be influenced by interest rates. If a country’s rates are deemed to be high or low against external currencies, this can determine whether that currency will be in high demand, or not, from foreign investors.
Economic Performance – If a country’s economy is performing well and forward indicators are looking positive, this can create a stronger valued currency.
Market Speculation – Markets are always looking ahead, trying to predict economic or political indicators that are likely to impact upward or downward trajectory. This is how speculators can create short-term market fluctuations.
Political (in)stability – Political uncertainty can have a major impact on currency values. Markets react to uncertainty, resulting in a currency’s weakness.
What pressures can impact international money transactions?
Timing: - Fluctuating exchange rates can have a big impact on the final amount received after a conversion has taken place. So, getting the timing wrong can have a big effect on the amount of funds received. This is especially pertinent for import/export businesses, who are regularly engaged with foreign trade.
Long term currency weakness: - At the same time, changes in exchange rates, particularly where one currency maybe experiencing long term decline or weakness against another, can seriously affect the value of foreign investments, such as property.
Fee disparities: - In addition, depending on who you use, some service providers will adjust their fees based upon market volatility.
MFX – Tips for Managing Exchange Rate Risks
Knowing how foreign exchange rates work is crucial if your business or CSP is engaged in international money transfers. Market volatility can lurk around every corner. So, it pays to work with a reputable money transfer platform that operates with in-depth market knowledge and is capable of delivering the most advantageous rates - whatever the prevailing economic climate.
Established in 2014 and part of the AIM-listed MFG Group, MFX is a dedicated Isle of Man-based foreign exchange brokerage, which works with businesses and CSPs across the Island and further afield. MFX is a long-standing partner of moneycorp, world leaders in international payments, who offer proven and effective foreign exchange, payment and hedging solutions.
If you need first-time assistance with your forex requirements or are looking for an alternative provider to the clearing banks for international currency transfers, call MFX directly on 01624 694722 or email Managing Director, May Hooper, at may.hooper@mfg.im