Floating Exchange Rate

Under a floating system, a currency's value changes constantly, rising when demand for it increases and falling when demand weakens. Factors influencing its value include interest rates, inflation, economic growth, trade balances, political stability and investor sentiment.

Most major currencies, including the US dollar, euro, Japanese yen, British pound and Australian dollar, float. Some countries operate a managed float, where the currency mostly floats but the central bank occasionally intervenes to smooth sharp movements.

For example, if a country's central bank raises interest rates, foreign investors may buy its currency to earn the higher returns, pushing its value up.

Floating exchange rates allow a country to set its own interest rates to suit its economy and help absorb economic shocks, since the currency can adjust automatically. For example, a weaker currency during a downturn can help exporters. The downside is greater uncertainty, as volatile exchange rates make it harder for businesses to plan and price international trade and investment.