Interest rates have a major influence on the forex market and a countries economy. The higher a countries interest rate the more likely it is for that countries economy to strengthen, and also the opposite when interest rates are lowered. This is because when rates are risen, people form other countries will put there money into the country to get better interest on their money. When rates fall people take their money out and invest into a country with higher interest rates. The more money being invested into a country the stronger the economy and the more demand there will be for the currency.
Why do interest rates change?
Interest rates change to keep the economy growing at a steady pace. The pace is set by the specific monetary policy of each county. When inflation (the cost of goods and services) is rising too quickly the central bank will increase interest rates to reduce growth and reduce inflation. This is to stop people spending and help them saving. businesses and consumers stop borrowing due to high interest rates and increase saving due to the high rates of return. The opposite happens when inflation is not growing quick enough, interest rates are dropped encouraging people to stop saving due to low rates of return and to borrow more due to low interest, this causes people and businesses to spend more raising inflation and causing the economy to grow.
Who sets interest rates?
Interest rates are set by the countries central bank.
UK – Bank of England / USA – The federal reserve / Europe – European central bank / Japan – Bank of Japan / Australia – Reserve bank of Australia / Canada – Bank of Canada / New Zealand – Reserve bank of New Zealand / Switzerland – Swiss national bank
Each bank adjusts the interest rates depending on their inflation rate target set in their monetary policy. Rates are usually only adjusted at rates of .25 to not create too much volatility in the market.
How to use interest rates to trade
Interest rate changes are usually already priced into the marked. Traders usually agree on an expected interest rate before news in announced causing the market to move reacting to the expected price days before any change is announced. When a interest rate change is announced it is important to look at what the expected rate change is and compare it to the actual change. If there is a difference between expected and actual this will cause volatility in the market.