A major factor affecting the foreign exchange (forex) market is interest rate changes made by major central banks such as the Federal Reserve of the United States, the Bank of England (BOE), and the European Central Bank (ECB). Interest rates are changed as part of their monetary policy in response to a number of economic factors, including inflation and growth.
Changes in interest rates can affect foreign exchange rates immediately and sometimes – substantially. Since these changes affect currency exchange rates, it is important to understand them in order to make high profits in forex trading.
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Effect of change in interest rate
When interest rates rise, forex traders want to buy currency and its exchange rate rises. On the other hand, when interest rates are cut, traders want to offload the currency, which causes its rate to drop. If thorough and timely research is done before interest rates fluctuate, a trader can protect himself from sudden exchange rate changes in most cases.
Although interest rates can be predicted with the help of correct economic models, surprising statements from a major central bank can, at times, leave the forex markets in a tizzy. Forex traders know that despite a lack of thorough research or numbers on projected interest rates, central banks can still deliver surprising rate cuts or hikes. When currency rates rise, traders can maximize their profits from market volatility.
Therefore, it is pertinent to know that the foreign exchange rates of all major currencies are always influenced by announcements made by major central banks including the Federal Reserve and the European Central Bank (ECB).
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But it is equally important to know that the announcements are a reflection of the major economic factors prevailing in the economy during that time. Conventional wisdom demands that staying abreast of those macro factors is as important as the announcements from the central bank that contain them.
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