How is the exchange rate determined and who regulates it?

Every day we hear about exchange rates in the financial news. This data is used in everyday life when planning overseas trips, shopping internationally, and building foreign currency savings to protect against inflation. Forex traders also deal with fluctuations in currency pairs on a daily basis, analyzing quote charts for the most profitable deals, assessing the economic state of countries and predicting future trends in the market.

But how exactly is the exchange rate formed? What does the euro rate depend on and what does the dollar rate affect? Let’s understand where quotes come from and who determines their value.

What is the exchange rate?

The exchange rate is the value of one currency expressed in units of another. This price is constantly changing on the chart, creating so-called quotes. In Forex, currency pairs are labeled as follows:

XXX/YYY

where XXX is the currency whose rate is being determined and YYY is the currency in which the value is calculated. For example, if the EUR/USD exchange rate is 1.2300, it means that 1 euro is worth 1 dollar and 23 cents.

Factors affecting the exchange rate

A lot of factors affect the exchange rate:

  • Supply and demand. Currencies are bought and sold like commodities, and investor interest determines their value.
  • Economic indicators. Inflation, unemployment rate, GDP, and other indicators gauge a country’s economic strength and stability.
  • Monetary policy. Central banks’ decisions on interest rates and money supply management affect inflation and confidence in a nation’s currency.
  • Political and economic stability. Emergencies such as wars, sanctions, crises, and natural disasters can cause capital outflows and alter currency exchange rates.
  • Global market events. Changes in sentiment in financial markets, especially those related to the currency of interest, also affect quotes.

Who shapes the exchange rate?

The most objective ratio of currency values is established in financial markets, where supply and demand reflect the reaction of market participants to global events. Private traders make money on the difference in exchange rates by buying currency cheaper and selling it more expensive through intermediaries – brokers. The exchange rates we see in the news are set by the Central Bank on the basis of transactions on the Moscow Exchange. These are average values of currency value calculated on the basis of trading results, and they serve as a benchmark for exchange operations in the country.

Who regulates exchange rates?

Central banks or similar government organizations regulate exchange rates. They use various instruments:

  • Interest rates. Rising rates strengthen a currency, making it attractive to investors, while falling rates in a crisis help stabilize the economy.
  • Open market operations. Central banks can use internal reserves to intervene in exchange rate movements.
  • Money supply control. Regulating the amount of money in circulation affects inflation and the exchange rate.
  • Currency interventions. In cases of severe volatility, central banks can stabilize the market.
  • Currency regimes. Countries can choose different policies for free floating and convertible currencies, from fully floating to fixed exchange rates.

Forex trading process

Forex (Foreign Exchange Market) is one of the largest and most liquid financial markets in the world. It is an over-the-counter market and has no specific location. The rates of currency pairs are determined by the supply and demand of market participants, including central banks, commercial corporations, investment funds and private traders. Each participant influences the quotes in its own way depending on the volume of transactions and strategies.

Conclusion

We have understood how the exchange rates we see in trading terminals, news and exchange offices are formed. This process involves many large financial organizations, companies and private investors whose actions affect the quotes. Understanding the factors that influence exchange rates is important for analyzing and predicting the market, as well as managing the risks associated with their fluctuations.