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How do exchange rates work?

An exchange rate tells you how much of one currency you could buy with another.

For example, this could be converting pounds sterling (GBP) to euros (EUR).

If the market rate for GBP/EUR is 1.10, for example, you’ll get €1.10 for each £1 you exchange (assuming you get the market rate and excluding any fees).

It works the same way in reverse. The EUR/GBP rate might be 0.90, meaning you’d get £0.90 for each €1 you exchange.

The rate directly affects the amount you get when you exchange currency.

Working out how an exchange rate will affect you

To work out how much of another currency you’ll get, just take the amount you want to exchange and multiply it by the exchange rate.

So, if you’re exchanging £500 into euros and the rate is GBP/EUR 1.10, then you’ll end up with €550 (assuming you get the market rate and excluding any fees). If the rate drops to GPB/EUR 1.05, then you’ll only get €525. 

If you want to change money back when you return home, you can do the same from euros to pounds. Say you have €200 left when you return and the rate is EUR/GBP £0.90, then you’ll get £180. Again, this assumes you get the market rate and excludes any fees.

Why are currencies exchanged?

Common reasons to exchange currencies include:

But currencies are also exchanged for other reasons, such as trade (buying goods and services from another country or region) and investment.

What makes exchange rates move?

A currency that's rising in value may show the economic health of that country or region is improving – or there’s the prospect of improvement.

How does inflation affect exchange rates?

Some inflation is healthy for an economy, as it shows there's an increasing demand. But too much inflation can be a problem, as goods and services become less affordable.

When setting official interest rates, central banks consider this balance. The Bank of England has an inflation target of 2%. In May 2024 it said UK inflation had fallen from a high of 11% in 2022, but it was still working to reduce it further.

But if inflation is rising too fast, a central bank may increase interest rates. Higher rates can make it more expensive to borrow and more rewarding to save, reducing demand and slowing inflation.

How do interest rates affect exchange rates?

Higher interest rates can increase a currency’s value. They can attract more international investment, which means more money coming into a country or region and higher demand for the currency.

If inflation is below its target level, a central bank may look to reduce its interest rates. This can make it cheaper to borrow and less rewarding to save, which encourages people to spend. The increase in demand can push inflation higher.

How does international trade affect exchange rates?

A country or region’s trading relationship with the rest of the world can also affect its currency. If it exports more than it imports, it’s known as a trade surplus. It will typically have a stronger currency than those with trade deficits.

Market expectations

Market expectations play a big part in exchange rate fluctuations. These expectations will take into account the factors we've outlined on this page.

Other economic data, such as Gross Domestic Product (GDP) and unemployment rates, will also affect market expectations.

The economic and political stability of a country or region does too.