If interest rates are higher in the United States than in other countries, then investors WILL choose to invest in the U.S, increasing demand for the dollar, provided that the expected rate of inflation is not higher in the U.S than among our trading partners. If INTEREST rates are LOWER in the U.S than in other countries, investors will choose NOT to invest in the U.S, decreasing demand for the dollar.
If the US INFLATION rate is HIGHER, investors are LESS likely to prefer the U.S even with higher interest rates- because of the expectation that the value of the dollar will be ERODED by inflation. If our INFLATION rate is LOWER, investors are MORE likely to prefer the U.S, because there will be NO expectation that the value of the dollar will erode.
Trade balance also has an effect on a country's currency. If world prices for what a country exports rise in comparison with the cost of that country's imports, that country will be earning more for its exports than it pays for its imports. The more demand there will be for that country's currency, the better the deal becomes. If investors are confident that the U.S economy will be strong, they will be MORE likely to buy American assets, pushing UP the dollar's value. If investors are not so confident that the economy will be strong, they will be LESS likely to buy the country's assets, pushing the dollar's value DOWN.
EUR/USD:
If
for
example,
a
Forex
currency
broker
believes
the
US
economy
will
continue
to
fall
and
that
will
hurt
the
U.S.
Dollar,
a
Forex
currency
broker
would
choose
to
buy
the
EURO,
expecting
the
EURO
to
go
up
against
the
U.S.
Dollar.
On
the
other
hand
if a
Forex
currency
broker
chooses
to
sell
the
EURO,
he
would
be
expecting
the
EURO
to
go
down
against
the
U.S.
Dollar.
USD/JPY:
If
for
example,
you
think
the
Japanese
government
is
going
to
deliberately
weaken
the
yen
in
order
to
help
its
export
industry,
you
would
choose
to
buy
the
U.S.
Dollar,
expecting
the
U.S.
Dollar
to
increase
in
value
against
the
yen.
If
you
see
Japanese
investors
are
pulling
money
out
U.S.
financial
markets
and
repatriating
their
funds
back
to
Japan,
you
would
choose
to
sell
the
U.S.
Dollar,
expecting
the
yen
to
strengthen
against
the
U.S.
dollar
as
Japanese
investors
sell
their
U.S.
assets
and
convert
their
Dollars
to
yen.
GBP/USD:
If
for
example,
you
believe
the
British
economy
will
continue
to
be
the
leading
economy
among
the
G7
nations
in
terms
of
economic
growth,
thus
causing
the
British
pound
to
go
up,
you
would
buy
the
pound,
expecting
the
pound
to
strengthen
against
the
U.S
Dollar.
If
you
believe
the
British
are
about
to
commit
them
selves
to
adopting
the
Euro,
you
would
sell
the
pound,
expecting
the
pound
to
weaken
against
the
U.S.
Dollar
as
the
British
devalue
their
currency
in
anticipation
of
merging
with
the
Euro.
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