Interest rates are the cost of borrowing money, set by a country’s central bank—such as the Federal Reserve (U.S.), Bank of England, or European Central Bank.
When central banks adjust interest rates, they do so to manage:
- Inflation
- Economic growth
- Employment
- Financial stability
Even the smallest rate change can have a massive impact on currency values.
Why Interest Rates Matter in Forex Trading
1. Higher Rates Attract Foreign Investment
When a country raises interest rates, investors around the world may buy that country’s currency to earn higher returns on:
- Bonds
- Savings
- Other interest-based investments
This increase in demand pushes the currency’s value up.
2. Lower Rates Weaken Currency Value
If interest rates fall, the country becomes less attractive to investors. Demand drops, and the currency often depreciates.
How Traders Use Interest Rates in Forex Trading
1. Fundamental Analysis
Interest rates are a core part of fundamental analysis. Traders analyze:
- Central bank statements
- Inflation data
- Economic reports
This helps predict future rate changes.
2. Carry Trading
Carry trading involves:
- Borrowing a currency with low interest rates
- Investing in a currency with high interest rates
The trader profits from the interest rate difference, plus any price movement in the pair.
Example:
Borrowing JPY at low rates and buying AUD at higher rates.
3. News Trading
Interest rate announcements often cause:
- High volatility
- Rapid price swings
- Breakouts or reversals
Skilled traders wait for central bank press releases and trade the reaction.
Major Central Banks Forex Traders Watch
Some key institutions include:
- Federal Reserve (Fed) – United States
- European Central Bank (ECB) – Eurozone
- Bank of England (BoE) – United Kingdom
- Bank of Japan (BoJ) – Japan
- Reserve Bank of Australia (RBA)
Each bank’s monetary policy affects global markets and currency direction.