How Does Interest Rates Impact Currency Values?

When Trading foreign currency, interest rates play a huge part in the value of the currency. When a country raises its interest rates, it can cause the value of its currency to appreciate, while a decrease in interest rates can lead to a depreciation of the currency. The higher the interest rate, the more foreign investors want to enter and thus driving up the price. On the other hand, if interest rates drop, investors will leave and go elsewhere.

Below we will introduce 3 ways interest rates impact currency values.

  Carry Trade

What is Carry Trade you ask? This is when a country borrows money from another country with low-interest rates and invests it in a country with high-interest rates. The profit is the earned difference. Using other people’s money, you can establish a system where you borrow money (low-interest rate) and buy assets (high-interest rate). This idea can lead to an increase in foreign capital in the country with high-interest rates which is an increased demand and thus increasing the currency price.

  Inflation

Another way in which interest rates can influence currency values is through their impact on inflation. Lower interest rates can increase the borrowing of money because it becomes less expensive to borrow money when interest rates are low. As a result, this increases the money supply and inflation grows larger. Alternatively,  higher interest rates decrease the borrowing of money because it becomes more expensive to borrow money when interest rates are high. As a result, this decreases the money supply and inflation reduces. This can lead to a decrease in price pressures and help to stabilize the currency.

  Economic Performance 

Interest rates also play a role in a country’s economic performance. Lower interest rates cause people to spend which leads to slower economic growth which decreases the currency’s value. Conversely, higher interest rates cause people to save which leads to faster economic growth which increases the currency’s value. 

Interest Rates and Currency Value is not black and white. Other variables come into play that may shift the dynamic such as wars and other world events. Central banks have many reasons to adjust interest rates such as lowering inflation or stimulating economic growth.

  Conclusion

Overall, the impact of interest rates on currency values can be complex and multifaceted. Higher interest rates can lead to an appreciation of the currency as they attract foreign investment and help to stabilize the economy. On the other hand, lower interest rates may discourage foreign investment and lead to a depreciation of the currency, particularly if they result in higher inflation. While interest rates are just one factor that can influence the value of a currency, they can play a significant role in determining its strength and attractiveness to foreign investors.