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Exchange Rate Movements And How They Affect Your International Transfer

February 10, 2015

Exchange Rate Movements And Your Transfer

If you need to send money to another country, here are two big things to watch out for:

  1. The hidden costs associated with the money transfer.
  2. The exchange rate itself.

Why?

First, banks, PayPal and other money transfer companies don’t do money transfers for free. They’re businesses so they need to make their money on every transaction. They do this by adding a ‘margin’ or ‘spread’ to the exchange rate they give you. This article won’t cover the hidden margin cost but you can read more about hidden money transfer fees here. Don’t forget that these companies usually also add upfront sending fees too.

Second, the exchange rate between currencies goes up and down all the time and it can either cost you a lot of money or save you a lot of money. In this article, we’re going to explain how exchange rates work and how they affect your international money transfer.

Let’s begin with an excellent explanation of how exchange rates work.

Currency Movements & How They Affect Your International Transfer

Exchange Rate Movements Explained [Video]

It’s not a recent video but it gives you nice, simple information that apply to any currency. In fact, the video uses the rise of New Zealand cinema to explain how the New Zealand dollar could go up or down. Afterall, we’ve seen some amazing films come out of there including:

  • The Piano
  • Lord of the Rings Trilogy
  • King Kong
  • The Lion, The Witch, And The Wardrobe
  • Bridge To Terabithia
  • Avatar
  • 30 Days Of Night
  • The Lovely Bones

This video explains how investment and tourist visits resulting from these movies could affect the exchange rate.

The video also answers the very interesting question of why a country would want to manipulate the value of its own currency. Obviously, this concept could apply to any other country – let’s take a look.

If you’re looking for some more information, the following summary might help.

How Economists Predict Future Exchange Rate Movements

Before we begin, please note that this is not financial advice – it is simply a description of some of the key factors that economists and market commentators take into account when trying to determine what will happen to exchange rates. These factors include: Interest Rate Movements, Economic Prospects, Expectations/Confidence, and Long Term Competitiveness.

For a description of these factors, we’ll turn to the nice folks at Economics Help.

Interest Rate Movements: Interest rates have the biggest single effect in determining exchange rates. Higher interest rates make it more desirable to save money in that particular country. This causes an inflow of hot money which leads to an appreciation in the exchange rate. International hot money flows account for a high % of capital flows.

Economic Prospects: Linked to interest rates is the general economic prospects of an economy. If an economy is slowing down, due to say, falling house prices, it is likely that interest rates will fall. This is because when the economy slows down, inflation falls, allowing Central Banks to cut interest rates. E.g. slower growth in the US has caused expectations of interest rates to fall, this in turn has led to the devaluation of the dollar.

Expectations / Confidence: This is an important factor which is harder for Economists to quantify. When Keynes was formulating his general theory, he used the rather unscientific term ‘animal spirits’. Here he was referring to business confidence. But it would not be entirely inappropriate to explain sentiments in foreign exchange markets. If people expect a currency to devalue, then it can become a self fulfilling prophecy. Because people expect the currency to fall, they sell and this causes the currency to fall. Because of the importance of expectations and market sentiment, currencies can often become divorced from economic fundamentals. This means that currencies can overshoot or undershoot their expected value. For example, 2007 saw a weak dollar due to falling interest rates, however, the bearish sentiment caused the dollar to fall by more than perhaps was warranted. The pound reached $2.12 before falling back to $1.95 a few weeks later. Like other markets, currencies can get caught up in their own hype – making forecasting a difficult business.

Long Term Competitiveness: It is argued that in the long term exchange rates will change to equalise differences in purchasing power. An example of this is using the Economist’s Big Mac index. This shows the local dollar price of buying a Big Mac. Countries where a Big Mac is very expensive, in theory, have an overvalued exchange rate. In principle, their exchange rates should fall in the long term to equalise the purchasing power of the currencies. However, currencies can be ‘overvalued’ or ‘undervalued’ for a long time due to other factors like general economic confidence.

Exchange Rate Movements And Your International Transfer

To summarise,

  1. Many money transfer companies have hidden costs associated with international currency exchange transfers. To learn more, click here.
  2. The exchange rate system itself is highly complex and based on a number of factors. Regardless of whether you try to read the market to predict future movements or use our recurring payments feature to make regular transfers to level out exchange volatility over time, the key is to use a money transfer service that does not charge a high margin on your transfers.

 

For more reading, check out:

Does The Exchange Rate Really Matter When Sending Money Abroad?

A Funny Explanation of Quantitative Easing [Video]

European Central Bank’s Announcement – How It Affects Currency Exchange Rates

What is a “Pegged Currency” and How Does it Affect Exchange Rates?

What Happened To The Swiss Franc (CHF)?

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