Why Are Forex Rates Important?

Forex rates are important because if a country's currency is weak, against that of another country, then the cost of importing goods will go up. After a time, this may have an affect on the price of goods in the domestic market of the country that has the weak forex rates, which may cause inflation to rise.

On the other hand, if a currency is strong against another currency, export prices may go up. This may mean that goods become more expensive, which could result in lower demand. After a time, this may reduce the exporter's need to produce these goods and this could cause the country a lot of problems.

Therefore, maintaining a balance among forex rates becomes important. Although central banks and governments don't exactly set forex rates, they do have some control over the rate by simply controlling the supply and demand of that currency. Central banks and governments can do this by adopting the following approaches:

A. Restricting the supply of money
You can restrict supply by:

• introducing regulations that prohibit certain actions (for example: the amount of money that can be taken out of a country, the level of daily trades / day trading or margin trading); and/or
  
  
• buying the excess supply itself; and/or
  
  
• not printing any new money.

B. Increasing the demand

On the other hand, you can increase demand by:

• raising interest rates – which gives investors more incentive to invest in that currency; and/or
  
  
• restricting the amount of available currency (based on supply and demand: same demand + less supply = higher rate).

Hopefully now you can start to see why controlling forex rate is so important – they have an indirect effect on everything else in the economy. Besides which, it is to keep everyone happy when they change their money to go on holiday!

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