If capital is allowed to flow freely, exchange rates will become stable and an equality of real interest rates is established. The real interest rate is the nominal interest rate, taking into account the prevailing inflation rate in the country.
In theory, the same goods should sell at the same price anywhere in the world (net of costs arising from barriers to free trade). This implies that either the price of goods or the exchange rate should adjust to make prices the same everywhere.
A positive macro-economic environment, including government policies, competitive advantages, etc, increases the demand for a Currency. Economic data such as Consumer Price Indices (CPIs), Producer Price Indices (PPIs), Gross Domestic Products (GDPs), international trade, productivity and industrial production figures also affect fluctuations in Currency exchange rates.
The major stock indices also have a correlation with the Currency rates. The demand for the Equity of a country gives rise to the demand for the Currency of that country.
All exchange rates are susceptible to political instability and speculation about new governments.
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