Learn Forex: Why Interest Rates Matter in Foreign Currency Trading?

1. Learn Forex: Why Interest Rates Matter in Foreign Currency Trading? For Forex day traders, interest rate changes are extremely important to follow. Here’s why: The central bank in every country sets interest rates and these rates have a direct impact on the value of a currency. Often, these rates are adjusted for economic reasons like to slow inflation and to encourage foreign trade. For example, lower interest rates are used to stimulate the country’s economy. With lower rates, borrowing costs are cheaper, and thus, citizens have more access to credit to buy houses, cars and spend on credit cards. Yet, when a central bank increases the rates, borrowing costs get more expensive, and in effect, economic growth slows down. The central bank of a country uses interest rates to control the country’s economy. If borrowing costs are kept low, even when the country’s economy is growing, inflation can occur and costs of goods and services will rise. People have more money to spend and that means more people are buying goods and services –there’s a greater demand – and those prices rise. By increasing the interest rates, the central bank can limit access to capital and, in theory, slow down inflation. Now, you’re probably wondering how interest rates affect currency values and why that information is so vital to Forex traders. Capital Flows and Forex Trading Rising interest rates encourage foreign investment in a country. For example, in the European Union interest rates are lower than they are in the U.S. In effect, an investor would earn more money in interest by buying U.S. securities. When interest rates increase, more foreign investments are attracted to the country. This is known as “positive capital flow.” And when a country

2. has a positive capital flow, there is an increased demand for that country’s currency. More people want to sell their own currency to invest in the currency with the higher interest rate. In effect, the currency’s value rises. Conversely, when interest rates are low, there’s a weaker demand for foreign investment in the country. This is known as “negative capital flow.” Fewer foreign investors are buying the country’s currency, which can result in stagnant or even declining currency valuations. How Interest Rates Affect Forex Trading Central banks meet every 4 to 6 weeks, and at these meetings, they may or may not adjust interest rates. Their decisions are based on a number of economic indicators including employment growth, wage growth and inflation rates. These meetings are very important for Forex traders. If a country alters their interest rate – whether lowers it or increases it – the markets react. Often, central banks will try not to surprise the markets and signal if they will adjust rates. The reason: Surprise interest rate changes can create volatility in the markets. Simply put, interest rates can positively or negatively affect a country’s currency valuation. Therefore, day traders must regularly analyze the economic data that’s factored into these rate changes, as well as announcements from the central banks, to better determine when a change may be coming. Presented By Learn To Trade