Supply and demand at the core
Like any price, an exchange rate moves when supply and demand shift. If global investors want more dollars, perhaps to buy US stocks or bonds, the dollar rises against other currencies. If exporters selling to Europe need euros, the euro strengthens. Every transaction in the foreign exchange market, from a traveler buying cash to a fund moving billions, feeds this balance.
What makes currencies special is scale: the foreign exchange market trades trillions of dollars a day, so even small shifts in sentiment can move rates within seconds.
Interest rates and central banks
Interest rates are the most powerful driver of exchange rates. When the Federal Reserve raises rates while the European Central Bank holds steady, dollar-denominated deposits and bonds pay more, attracting global capital into dollars and pushing the dollar up against the euro.
Central bank communication matters as much as the decisions themselves. A hint that rates will rise in six months can move the currency immediately, because markets trade on expectations. This is why speeches by the Fed, ECB, Bank of England, and other major central banks are watched minute by minute.
Inflation and purchasing power
Inflation erodes a currency's purchasing power. If prices in the eurozone rise faster than prices in the US, a euro buys less at home over time, and the currency tends to weaken relative to the dollar. Over the long run, currencies with lower inflation tend to appreciate against currencies with higher inflation.
This relationship, called purchasing power parity, works over years rather than days. In the short term, it is often inflation surprises, data that comes in higher or lower than expected, that move rates, because they change expectations about future interest rate moves.
Economic data and market sentiment
Monthly indicators like US Non-Farm Payrolls, eurozone inflation figures, and GDP releases regularly move currency pairs. A strong jobs report suggests the Fed may keep rates high, strengthening the dollar; weak data does the opposite. Markets react to the difference between the actual number and what was expected, not to the number alone.
Sentiment can amplify these moves. When investors are confident, they favor higher-yielding currencies; when fear dominates, money flows into perceived safe havens like the US Dollar and Swiss Franc, regardless of economic fundamentals.
Politics, geopolitics, and speculation
Elections, trade disputes, and conflicts create uncertainty, and uncertainty usually weakens the currencies most exposed to it. The British Pound's post-2016 fall after the Brexit vote and its sharp drop during the 2022 mini-budget crisis are textbook examples of politics moving exchange rates.
Speculation adds another layer. Traders and funds position for expected moves, and large positions being opened or unwound can move rates sharply in the short term, sometimes overshooting where fundamentals suggest the currency should be.
What this means for your conversions
You cannot predict short-term exchange rate movements reliably, but you can work with them. Track the rate for the pair you care about, understand the main drivers, and avoid converting large sums in the middle of major central bank announcements or political turmoil.
For regular transfers, converting a fixed amount on a schedule or splitting a large conversion across several days smooths out volatility. And no matter where the rate stands, comparing provider markups against the mid-market rate protects you from the one cost you can control.