The Relationship Between Interest Rates and the Forex Market

Everyone who participates in the Foreign Exchange Market takes an interest in changes in the interest rates of the countries whose currency they are contemplating buying or selling. Yet what form that relationship takes is largely dependent upon the perspective of the investor. Interest rates can be interpreted in a number of ways based on what your investment strategy is, so no two investors may draw identical conclusions about what those interest rates mean. 

Inflation Rate and Forex

The key concern to the Forex trader is whether interest rates are going up or down. Rising or already high interest rates are usually of the greatest interest since it is often the byproduct of high inflation. Raising interest rates is a common remedy used by central banks to try to control inflation and because inflation lowers the value of a currency it is almost certain to have an influence on exchange rates, but not necessarily a negative one.

When it comes to the value of assets, high interest rates are attractive because it means a higher rate of return. Higher returns will usually translate into an increase in demand for that currency which in turn will raise the exchange rates. Lower interest rates tend to have the reverse effect.

But none of this is set in stone, and the interpretation of interest rates and their relation to the Forex market is often complicated and subtle. For example, an increase in interest rates is not always seen by the currency market as a positive since it can be an indication of future financial trouble that will actually lower an investment’s value long term. Therefore instead of attracting investors, rising interest rates can cause investors to begin moving their investments out of that currency so as not to get stuck in a mounting financial crisis.

So in other words, high interest rates can be good for the Forex market investor, except when it isn’t. If that sounds confusing and contradictory, that’s because whether rising or falling interest rates are good or bad for your investments is something only you can decide based on your own Forex market investment strategy. That is why it is essential to consider interest rates in your overall investment plan so that you can judge these fluctuations against your own personal financial goals to determine whether changing interest rates are telling you to buy, sell or hold.