Interest rate

    By
    Andrey Orlov
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    What are interest rates in trading?

    When one party lends money to another, the interest rate is the fee the borrower has to pay for his debt to the lender.

    On a national level, a base rate is set by the country’s respective central bank — it is this rate at which banks pay to borrow money from the central bank. This cost of borrowing is passed on to the bank’s own customers.

    If the central bank of an economy increases the interest rate, it effectively makes borrowing more expensive throughout the economy, because this cost is passed down to the bank’s own borrowers in the form of higher interest rates and payment.

    The base rate of interest a central bank sets has a significant impact on the inflation in a country. Monitoring and analysing interest rates are also an important concept of fundamental analysis.

    Forex trading and interest rates

    Central banks have a big impact on forex trading because the interest rate they set has a substantial effect on the value of a currency. If the interest rate is high, the rate of return for holding capital in that currency will also be high. This results in an increased demand for the domestic currency, which causes the value of that currency to rise.

    For example, the New Zealand central bank traditionally sets high interest rates, making the New Zealand dollar attractive.

    The Japanese central bank traditionally sets low interest rates, so the New Zealand dollar will naturally attract Japanese investors, and the subsequent capital inflow will lead to an appreciation of the New Zealand dollar. The investors would need to swap Japanese yen for New Zealand dollars, leading to a devaluation of the yen. This would increase the value of the NZD/JPY currency pair.

    Read more on the impact of the interest rate on forex trading and currencies in general:

    Economic indicators and their impact on currencies