Good day, fellow traders! The topic of interest rates often appears on the agenda of various media and many are aware that it is closely connected with the global economy and finance and somehow affects the processes taking place in the foreign exchange markets. But what do interest rates really mean and why do they influence Forex trends?
The interest rate is the rate at which the central bank lends to commercial banks. They, in turn, lend to commercial companies based on this official rate. If the rates are high, then the loans are more expensive and so are the goods on the markets, and therefore less competitive. The demand for loans falls, inflation slows down and, consequently, the currency becomes more expensive.
Conversely, if rates are low, then commercial banks and then companies take loans at lower interest rates (sometimes negative), which allows you to sell goods cheaper, the Central Bank prints more money and inflation accelerates the currency becomes cheaper.
Monetary policy: why and how rates are regulated Rates can be high or low. However, these values are always relative, so it is important to consider the historical trend and the rise/decline in relation to their own historical values. The central bank raises the rate to prevent the economy from overheating. This happens when there is no room for growth in the economy and prices begin to rise outside of real increases in the production of goods and services, which leads to accelerated inflation and a depreciation in the trade rate of the currency.
A rate hike slows inflation and makes the currency more attractive in the eyes of investors, and commercial banks deposit investor funds at a higher interest rate. In contrast, a rate cut is stimulative and serves to accelerate economic processes, cheap credit for business, low taxes, lower unemployment, and increase business activity. This accelerates inflation and lowers the trade rate of the currency.
When and how often interest rates are changed Central banks independently determine the timing of interest rate reviews. In the U.S., for example, rates are regulated by the Federal Open Market Committee (FOMC). And needless to say, the whole world is watching their meetings. Usually, special committees of national central banks adopt a particular monetary rate at the beginning of the fiscal year, but, if necessary, they can change it later.
In the EU, the refinancing rate is regulated by the European Central Bank. In the United Kingdom, it is the Bank of England. In Japan it is the Bank of Japan and so on. The markets also take into account the rates of Switzerland, Canada, RBA, Norway, China, India, Korea and some European countries such as France, Italy, Germany, Spain and others.
What happens in the forex market? If you opened the economic calendar and found that the officials of a national Central Bank are meeting to decide on interest rates then the rates may change and change the trend, depending on whether they are going down or up.
Or rates can remain at the same level, and then the trend will be determined on the basis of the current dynamics: if last time rates were cut then the trend will be bearish, and if they were raised it will be bullish.
As a rule, the prospects for rising or falling rates are repeatedly announced for a long period before they are changed. Long-term investors and position traders take advantage of this to take profits or to avoid risks.
Conclusion • Watching interest rates is important to understand the global currency trend; • A decrease in interest rates stimulates the economy and an increase in interest rates cools economic growth; • If interest rates rise, the currency strengthens; if they fall, it weakens.