Microeconomic Indicator in FOREX:
What is Interest Rate?
Interest rate is nothing but the fee that you are supposed to pay for the money you borrowed from the lender. Anyone can lend you money and charge interest, but it’s usually banks. Interest rate is generally expressed as a percentage on the principal amount. The principal is the total amount of money lent or borrowed. It is calculated on the principal you borrowed from the lender for using their money. If you borrow money, to fulfil any of your needs you are bound to pay interest. It can either be for a home, vacation or personal loan you are supposed to pay interest on it. On the other side, if you have deposited your money in a bank, it is kind of considered as you lent your bank some money and you will be paid some interest as a lender and the amount you deposited will be considered as the principal amount.
The interest rate that is set by your bank either to pay you interest, if you have deposited some money or to charge you interest, if you have borrowed some money. This rate is based on the RBA’s official cash rate. That determines the amount of interest you will earn or pay. The banks use the deposits you made from the savings accounts to provide loans to others. They pay interest rates to the depositors to encourage more people to deposit. The banks make a profit by charging borrowers a higher interest rate compared to the interest rate they pay to their depositors. Banks also compete with each other for more depositors and borrowers and that’s the reason why the interest rates of all banks are almost similar.
What does it measure?
If there is a hike in the interest rates, the growth of the economy decreases and the inflation gets slower. On the contrary, if there is a cut in the interest rates, there will be greater economic growth and faster inflation. The higher the interest rate of a country, it is more likely that the country’s currency will strengthen and the currencies with lower interest rates are more likely to weaken in the long term. Domestic interest rates will have a direct impact on how the traders perceive the value of a currency compared to others.
Reliable source of information on ‘Interest Rate’ for Major currencies:
There is a lot of information with respect to the Interest Rates in the sources provided below. You can familiarise yourself with the Interest Rates of the respective country along with the historical data related to that country’s Federal Interest Rates. You can also compare the Interest Rates of one country to the other using this web portal. The graphical representation of the historical Interest Rates data will give you a clear understanding of how the country’s Interest Rates changed over time. You also get to change the graphical representations according to your preference. A ton of more information related to the latest news in that regard is provided to give you a better understanding.
BP (Sterling) – https://tradingeconomics.com/united-kingdom/interest-rate
What do traders care about the Interest Rate and its impact on the currency?
The ‘interest rates’ are usually referring to the rate of interest that is charged by the central bank. Forex traders consider these interest rates as vital and give them a lot of importance because when the expected rate of interest changes, the value of the currency fluctuates.
There are a lot of things that affect the exchange rate movement between countries. It is never a bad idea to gain interest on the money you own and which is stagnant. If you are a forex trader with an active forex trading account, you can invest your money in any of the foreign currencies that pay high interest. The difference in the interest rate can make you money when you find a country that has a very low interest rate. Forex traders all over the world generally pick a currency which has a high rate and also pick a currency with a very low one. They hold the currency that pays more interest. Then by using daily rollover, they get paid daily on the difference in interest rates between the two country currencies. This method of making money solely on the interest rates of currencies is known as Carry trading.
What control do Central Banks have?
Central Banks are not the institutions that have the authority to set interest rates for the loans we borrow like personal loans, mortgage loans, housing loan etc. But they do have control over the factors that can impact the interest rates and can get them to desired levels. Central banks control the policy rate. This is the rate at which commercial banks borrow loans from the central bank. This policy rate is called Federal Discount Rate in the United States and it is controlled by the central bank.
Frequency of the release
Interest Rates are ever changing as per different events and situations, but they definitely don’t change that often. However, the forecasts on the direction of the interest rate change on a week-to-week basis. All presidents of the Reserve Banks attend meetings and participate in discussions to evaluate the interest rates. These meetings happen eight times a year and once every six weeks approximately.
The Bottom Line
Numerous factors affect the value of a currency, and interest rate is definitely one of the crucial factors. Consider these interest rates of the currencies while you trade to make the fundamentals of your trade stronger. Being a forex trader, it is always advised to look at the complete picture on how is the economy of the country is doing? Why the interest rates are continually fluctuating etc. Most importantly you need to know more about the country that you are pairing the high-interest currency against. This is because at times it is the high-interest currency in the pair that is causing the movement and sometimes it’s both the currency pairs. Hence it is always advised to take the entire picture into account.