Exchange rate forecasting: 7 key methods and when to use each

As a CFO of a small to medium-sized enterprise (SME), it's essential to keep an eye on currency exchange rates to protect your business margins. Fluctuations in currency exchange rates can have a significant impact on your company's bottom line, especially if you're involved in international trade.

But with so much information available, it can be challenging to know where to start when it comes to forecasting currency exchange rates. In this article, we'll break down the basics of the currency market and provide you with the tools you need to make informed predictions about future exchange rates.

What is the currency market?

The currency market, also known as the foreign exchange market or forex market, is the largest financial market in the world. It's a decentralised market where participants buy, sell, and exchange different currencies, 24 hours a day, five days a week.

The currency market is influenced by a range of factors, including interest rates, inflation rates, political stability, and economic growth. All of these factors can impact the value of a currency and, in turn, the exchange rate between two currencies.

Why exchange rate forecasting matters for your business

Currency fluctuations can turn a profitable contract into a loss before you ever receive payment. An exporter with a 15% nominal margin can see real margins swing from -30% to +30% depending on how exchange rates move.

The gap between quoting a price and getting paid creates currency exposure you can't ignore.

Forecasting exchange rates helps you anticipate these movements so you can make informed decisions about when to convert funds, when to lock in rates, and how much risk you're comfortable carrying. The goal isn't predicting the market perfectly. It's minimising risk from swings you didn't see coming.

7 methods for forecasting currency exchange rates

There are several approaches you can use to forecast exchange rates, each with its own strengths depending on whether you're focused on short-term movements or long-term trends.

1. Fundamental analysis

Fundamental analysis involves studying the economic, political, and financial factors that impact currency exchange rates. This method looks at indicators such as inflation rates, interest rates, and GDP growth to make predictions about future exchange rates.

2. Technical analysis

Technical analysis forecasts exchange rates by studying past price trends and chart patterns. The underlying assumption is that historical patterns repeat themselves — market psychology creates predictable behaviours that show up again and again.

This method works best for short-term forecasting, typically days or weeks rather than months. Common tools include moving averages, support and resistance levels, and momentum indicators that help identify when a currency pair might be due for a shift.

3. Purchasing power parity (PPP)

Purchasing power parity is built on the "law of one price" — the idea that identical goods should cost the same in different countries once you account for exchange rates. For example, if a product costs €100 in Germany and $110 in the US, PPP suggests the EUR/USD rate should be 1.10.

When actual rates deviate from this balance, the theory predicts they'll eventually move back. That makes PPP more useful for long-term forecasting over multiple years — not necessarily for predicting what may happen next week or next month.

4. Relative economic strength

This approach compares the economic health of two countries (or more) to predict which currency will strengthen or weaken. A country with stronger GDP growth, higher interest rates, and stable inflation tends to attract foreign investment — and that investment increases demand for its currency.

The core question being asked is simple:

Which economy looks more attractive to investors right now?

Like PPP, relative economic strength works better for medium- to long-term forecasts than for predicting short-term swings.

5. Econometric models

Econometric models use statistical techniques to forecast exchange rates based on historical data and the relationships between variables. These models might factor in interest rate differentials, trade balances, and inflation gaps — anything measurable that's shown predictive value over time.

ARIMA (Autoregressive Integrated Moving Average) is one common approach, using past exchange rate data to project future values. These forecasting methods require significant data and expertise to build, but they can capture complex relationships that simpler approaches miss.

6. Economic reports and news-based analysis

News-based analysis tracks events and data releases that could move currency markets. Central bank decisions on interest rates often trigger immediate, significant currency movements — making them critical to watch.

Scheduled releases like employment reports, inflation data, and GDP figures give you specific dates to monitor. But unexpected news is harder to plan for. Elections, geopolitical conflicts, and natural disasters can all shift exchange rates rapidly and unpredictably.

7. Market sentiment

Market sentiment reflects the overall mood among traders and investors. It's shaped by data releases, political events, and sometimes just rumour — and it can diverge from fundamentals in the short term. Currencies sometimes move on perception rather than reality.

Tools like the Commitment of Traders (COT) report show how large institutional players are positioned. When sentiment becomes extreme — overly bullish or bearish — it often signals a potential reversal ahead.

Key factors that influence exchange rates

Understanding the factors that drive currency movements helps you interpret forecasts and spot potential risks before they hit your bottom line.

Interest rates, Federal Reserve and other central bank policies

Central banks like the ECB, Federal Reserve, and Bank of England set interest rates that directly influence their currencies.

Higher rates tend to attract foreign investment — investors want better returns, which increases demand for that currency and pushes its value up. Lower rates have the opposite effect — investors move money elsewhere seeking better returns.

Monetary policy announcements often trigger immediate market reactions, so keeping an eye on central bank meeting schedules matters if you're managing currency exposure.

Inflation and purchasing power

Countries with consistently low inflation tend to see their currencies appreciate over time. Purchasing power holds steady, which makes the currency more attractive to hold. At the same time, high inflation works against you. The same amount of money buys less, eroding the currency's value and driving currency fluctuations downward.

Inflation differentials between countries are one of the key economic factors behind PPP-based forecasting — and a useful signal when comparing two currencies over the long term.

Economic growth and GDP

Strong economic growth signals a healthy economy, and healthy economies attract foreign investors. That inflow of capital increases demand for the local currency and pushes its value up.

GDP reports, employment figures, and manufacturing data all feed into market expectations about a country's trajectory. When economic reports come in better or worse than expected, the surprise often triggers significant currency moves. Markets price in what they anticipate, so it's the gap between expectation and reality that matters most.

Political stability and geopolitical events

Political uncertainty makes investors nervous. Capital tends to flow toward stable environments and away from risk, which is why political events can drive currency fluctuations just as much as economic data.

Elections, policy changes, trade disputes, and conflicts all introduce volatility. For example, Brexit, the war in Ukraine, and shifting trade policies in the United States have all created major FX market movements in recent years. These factors are harder to model than inflation or interest rates since they're often tougher to predict, but ignoring them isn't an option either.

The limits of exchange rate forecasting

Even professional forecasters with sophisticated models struggle to predict currency movements consistently. The further out you look, the less reliable any forecast becomes.

Part of the problem is that unexpected events can invalidate months of careful analysis overnight:

• A pandemic reshapes global trade flows
• A surprise election result shifts policy direction
• A central bank pivots on interest rates without warning

Events like these happen regularly in currency markets.

Exchange rate forecasting isn't about trying to make perfect predictions on which direction every currency pair is going to move. Its real value lies in understanding your exposure and making informed decisions about how to manage it.

How to use currency forecasting to protect your profit margins

Forecasting alone won't protect your margins — but it gives you the information you need to act. That means knowing when to lock in rates, how often to review your exposure, and who to lean on for guidance.

Lock in rates with forward payment contracts

A forward payment contract lets you secure today's exchange rate for a payment you'll make weeks or months from now. This removes the guesswork from forecasting — you know exactly what your costs will be regardless of how the market moves.

If you're working with iBanFirst you'll have access to three different types of forward payment contracts:

• Fixed forward contracts: Lock in a rate for a specific amount on a specific date — ideal when you know exactly when a payment is due
• Flexible forward contracts: Lock in a rate but draw down the funds at any point within an agreed window — useful when payment timing is less predictable
• Dynamic forward contracts: Lock in a minimum rate while retaining some ability to benefit if exchange rates move in your favour

Forward contracts are particularly useful when you have fixed-price contracts with customers but variable costs in foreign currencies. Again, you're not trying to beat the market — you're minimising risk by trading potential upside for certainty and predictable margins.

Build a recurring FX review process

Set up a monthly or quarterly review to assess your upcoming foreign currency obligations and currency exposure. Look at what's due in the next 60-90 days and decide where you need certainty versus where you can accept some variability.

Over time, compare your exchange rate forecasts to actual payments. Fewer surprises means your approach is working. A simple rule like assessing FX risk for any future payments over, say, €10,000 creates structure without adding complexity. The goal is avoiding a "set it and forget it" approach that leaves you exposed when key factors shift.

Work with FX specialists who understand your exposure

Currency markets are complex, and most SMEs don't have dedicated treasury teams to manage FX risk. Working with FX specialists gives you access to market insights and guidance tailored to your specific payment patterns and currency exposure.

A good specialist helps you understand which forecasting factors matter most for your currency pairs — and when locking in rates makes sense. The goal is predictable, manageable exposure and informed decisions about minimising risk. Not trying to time the market perfectly.

Protect your margins with iBanFirst

Forecasting gives you visibility into where exchange rates might be heading. But visibility alone doesn't protect your margins — you need the tools and support to act on what you learn.

iBanFirst gives growing international businesses a single platform to manage currency exposure and cross-border payments. With iBanFirst, you can:

• Lock in exchange rates with fixed, flexible, or dynamic forward payment contracts
• Hold and convert 25+ currencies when the timing is right for your business
• Send cross-border payments with transparent pricing and fast settlement
• Track payments in real time from initiation to arrival
• Access FX specialists who understand your exposure and can guide your approach

Ready to take control of your currency exposure? Request an account and see how iBanFirst can help protect your margins from the currency swings you can't predict.