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What economic indicators are most used when forecasting an exchange rate?

Modified on: 2018/07/11
A:

The economic indicators used to forecast an exchange rate are the same ones used to determine the overall economic health of a country. The gross domestic product (GDP), consumer price index (CPI), producer price index (PPI), employment data and interest rates are all key determining factors of a country’s foreign exchange rates.

Exchange rates are among the top factors that distinguish the health of a country's economy. Also known as a forex rate, the foreign exchange rate is the value of the currency of one nation in relation to another nation's currency.
The GDP) of a country is a representation of the dollar value of goods and services that have been produced within that country, generally over the span of one year. The GDP may also be thought of as the basic size of the country's economy. Changes in the GDP reveal changes in economic growth and can directly impact the relative value of a country’s currency. A high GDP reflects larger production rates, an indication of a greater demand for that country's products. An increase in demand for a country's goods and services generally translates into an increased demand for the country's currency.

The CPI is another important indicator for investors and economists and is a metric for changes in price of a predetermined group of goods and services which are bought by households within a country. The CPI is used to track price changes and reflect inflation rates. A rise in prices on the CPI indicates a weakening in the purchase power of the country's currency. Especially high inflation relative to inflation rates in other countries magnifies the effect of this factor.

The PPI measures the average change in sale price of all raw goods and services, and it examines these changes from the viewpoint of the producer and not the consumer. The PPI and CPI are obviously interrelated; increased producer costs are most often passed on to consumers.

Employment data is another indication of a country's exchange rate. Higher employment rates are typically a sign of higher demand for production of the country's goods, so it is therefore a signal that the value of a country's currency is higher. Greater demand for products and services from a country results in an increase in the number of workers required to meet the demand. Higher demand usually means a country is doing more exporting, and more foreign currency is being exchanged in favor of the home country.

One final indicator widely used to forecast the exchange rate of a country is the interest rate set by its central bank. A country offering higher interest rates is usually more appealing to investors than a country offering relatively lower rates.


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