Influence of Interest Rates on the Forex Market
Effect of Interest Rate Increase
In the forex market an increase in interest rates will affect the currency exchange rate and for more details we take the example of the GBP / USD currency pair with the pound (GBP) 0.5% and the dollar (USD) 0.5%. Assume, the American central bank (The Fed) raises interest rates from 0.5% to 0.75% (up 0.25%) while the UK region rates are fixed so many investors will divert investment instruments in the form of stocks or other currencies into the form of an eye. dollar (USD).
And if we look through the chart of the GBP / USD currency pair it will look bearish which means that many investors or speculators buy the dollar (USD) and sell the pound (GBP). And bearish conditions may occur in other currency pairs such as xxx / USD or USD / xxx if other regions do not raise interest rates. The increase in the volume of purchases of dollar (USD) by investors because it is considered that the currency provides higher returns compared to other investment instruments.
Effect of Interest Rate Decreases
Same with the effect of the increase in interest rates that the reduction in interest rates will affect the exchange rate of the currency. We take another example of the GBP / USD currency pair with each region’s interest rate of 0.5% as shown in the table above. When the American central bank (The Fed) lowers interest rates from 0.5% to 0.25%, many investors will sell the dollar (USD) which is an investment instrument into investments such as stocks or other currencies that provide higher returns.
And if we look through the chart of the GBP / USD currency pair it will look bullish which means that many investors or speculators sell the dollar (USD) and buy the pound (GBP). And this condition will also occur with other major currency pairs such as xxx / USD or USD / xxx if other regions do not raise interest rates.
So it can be concluded that the influence of the increase or decrease in interest rates is very large on the movement of currency exchange rates and we as money market investors or forex traders must really pay attention to the issue or policy that will be taken by the central bank in running its economy because this has a very big against volatility in the forex market.