What primary factor influences exchange rate changes in the short term?

The primary factor that influences exchange rate changes in the short term is surprise changes in interest rates. When central banks announce unexpected adjustments to interest rates, it can lead to significant fluctuations in currency values almost immediately. This is because changes in interest rates affect capital flows; higher interest rates typically attract foreign investment, increasing demand for that country's currency and leading to appreciation in its value. Conversely, lower or unexpected decreases in interest rates can cause a currency to depreciate as investors may seek better returns elsewhere.

While long-term economic growth, international trade flows, and government fiscal policies can all have observable effects on exchange rates over extended periods, they do not typically influence exchange rates as rapidly as surprise interest rate changes. Economic growth often reflects a trend that operates over longer timeframes, international trade flows are influenced by numerous factors that may not change quickly, and fiscal policies generally have a delayed impact on interest rates before they reflect in currency values. Therefore, surprise changes in interest rates are critical as they directly affect market sentiment and investor behavior in the short term.