Introduction:

Interest Rate is among the most important fundamental data that impacts the currency of a country. It's of vital importance for any trader to keep a watch on this important data for his or her trading activities. A change in Interest Rate viz. a hike or a cut could be a percursor to a long term bearish or bullish bias respectively on the currency.

Interest Rate is the also most important tool major Central Banks around the world like FED, ECB, BOJ, PBOC etc use to guide the economy and the overall markets to its desired goals. Interest Rates are set by Central Banks to majorly keep inflation within a limit and to promote or curb lending. For instance, if prices for essential items and inflation are ballooning in conjunction with better economic conditions, Central Banks will hike Interest Rate to curb money supply to control price rise and inflation.

How Rates are calculated? :

Board of Directors of Central Banks controls the monetary policy of its country. They set the short-term interests at which banks can borrow from one another. Central Banks gather various relevant economic indicators from its economy to decide on Interest Rates to keep as its is or to cut or to hike. For instance after examining the economic indicators, the Central Banks want to encourage lending and inject money into the economy, it will cut rates and vice versa.

Economic Indicators that Central Banks examine are :
  • The Consumer Price Index (CPI)
  • Consumer Spending
  • Employment Levels
  • Subprime Market
  • Housing Market

Effect of Changes in Interest Rate

A country with higher interest increases the value of that country's currency relative to nations offering lower interest rates. However, this situation could change and is also not always a simple-line calculation. The final determination of a country's currency rate with relative to other currencies is a result of various interrelated economic and other factors like GDP, balance of payment, level of debts, etc.

But in spite of these various factors, higher interest rate generally increases the value of a country's currency. Raising Interest rate can attract foreign investment resulting in increase demand of the currency because of the higher interest earned. A currency with high interest rate paired with a currency with low interest rate could be traded in a strategy called Carry Trade.

Interest Rates of Major Economies

Current Interest Rates of important economies around the world are given below:

Central Banks Current Rate Last Change
  • Federal Reserve (FED) 0.50% Dec 16, 2015(25bp)
  • European Central Bank (ECB) 0.05% Sept 04, 2015(-10bp)
  • Bank Of England (BOE) 0.50% Mar 05, 2009(-50bp)
  • Bank of Japan (BOJ) -0.10% Jan 29, 2016(-20bp)
  • Swiss National Bank (SNP) -0.75% Jan 15, 2015(-50bp)
  • Reserve Bank Of Australia (RBA) 2.00% May 05, 2015(-25bp)
  • Bank of Canada (BOC) 0.50% Jul 15, 2015(-25bp)
  • Reserve Bank of New Zealand (RBNZ) 2.50% Dec 09, 2015(-25bp)
  • People's Bank of China (PBOC) 4.35% Oct 23, 2015 (-25bp)
  • Central Bank of the Russian Federation (CBR) 11.00% Jul 31, 2015 (-50bp)

Conclusion:

Using interest rate data and knowledge of the direction of change in interest rate could be crucial in a profitable forex trading experience. Cycle of Interest rate increase or cut in USD have happen in period of 5-10 years historically. Will FED be able to normalize its Interest Rate after the QE kick off in 2008?
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