The Influence Of Interest Rate On Exchange Rate

Posted by sophiamilller on January 9th, 2013

The models used for macroeconomic exchange rate are structured based on a fundamental analysis. As a very simple example when using the US Dollar as reference, the currency rate will be affected when there is a difference between demand and supply. If the supply is higher than the demand, prices will fall and if demand is higher than supply, prices will rise. However, there are so many things that we can talk about when determining rates, including interest rates.

The problem is that currency rate is governed by much more that just supply and demand as people do not use currency in order to just buy foreign services and goods. For instance, currency can also be used for investments in another country or speculations. Different variables have to be considered whenever analyzing rate movements. What you might not know is the fact that there are differences between interest rates noticed from one country to another.

Interest can be defined as price paid in order to convince people to save money instead of spending or to make a long term investment instead of holding on to cash. The interest rates will be effected by savings supply and capital demand. Inflationary expectations have a huge demand on interest rates and even noticed currency rate. The market is complicated and so many things can be analyzed. A professional will often spend days in analyzing trends.

The global investors will want to achieve a return on investments that is as high as possible. This can only be done when exchange rate is analyzed properly and future inflation is analyzed properly. Forecasts about the evolution of inflation and interest rate are vital in achieving a real return on investments. It is very hard to understand the links between interests and currency evolution.

Let us think about an example. When the interest rates in Australia are higher than those noticed in Japan, investors from Japan will want to invest in Australian bonds in order to make more money due to higher rates. In order to buy bonds, they need to analyze exchange rate and sell Japanese Yen. Australian Dollar has to be used for the bonds. The Japanese investors will not keep their money in Australian bonds forever. They will want to get the profit back and in order to do this a new exchange has to be done by selling Australian Dollars and Buying Japanese Yen.

To put it simple, expected exchange rate movement between two currencies can be taken into account in order to see what will happen and what move would be more profitable. Interest rate is always calculated by an investor and future rate movements have to be anticipated properly to make money. The predictions done by investors will be impacted by the inflation rate in a country. When inflation rises in one country above interest rates, investors automatically understand that a currency weakening is soon to happen. If you want to make smart investments, always take into account interest rates as differences will appear in the noticed exchange rates.

Understanding exchange rate and currency rate is vital for every single investor in the world. Learn as much as you can about it and see how you can use your knowledge to make profit.