Fundamental analysis: the interest rate and its impact on the exchange rate. 1/2

Finishing the cycle of articles on fundamental analysis, it is worthwhile to talk separately about the interest rates of central banks (CB) and their impact on the exchange rate of world currencies. Earlier, the basic topics of any economy were discussed: GDP, inflation and employment. So, the interest rate and its impact!

General concepts

The official interest rate of the Central Bank is the interest rate at which the central bank issues funds to commercial institutions, thereby regulating the  country’s general state of the economy.

It is believed that the change in the official interest rate is the key way in which the Central Bank influences the economy. Thus, the central bank regulates such concepts as cooling and overheating of the economy and has a direct impact on the exchange rate of the national currency.

  • A decrease interest rates is used to accelerate economic processes. Cheap loans increase business activity and inflation thereby exerting pressure on the national currency. This approach is used to stimulate economic growth.
  • An increase in rates makes loans more expensive and reduces inflation, attracting investors to the currency and strengthening it against currencies with lower interest rates.

The situation with interest rates at the moment

In 2018, advanced economies moved to the stage of increasing interest rates after their decline during the crisis period of 2007-2008. A return to aggressive monetary policy not only points to a way out of crisis, but also to the intentions of a country to tighten monetary policy, which is based on the growth of economic factors.

 

Fig. 1. Chart of interest rate growth in the US

Fig. 2. Chart of interest rate growth in the UK

Fig. 3. Chart of interest rate growth in Germany

 

Since the change in key interest rates is one of the main methods of regulating the economy, the Central Bank can resort to it at any time. There is no clear plan for raising rates in any given country. There are only forecasts and expectations, which in themselves have an impact on the market.

Typically, interest rates are changed at central bank meetings, which can be monitored using the Economic Calendar.

In the next article, we will consider examples of changing rates impact on the foreign exchange market.

Anton Hanzenko

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