In the forex market, interest rate can be defined as the cost of borrowing money. Interest rate can also be the recompense for the service and risk involved in lending an amount of money to someone. Without the term interest rate, forex traders in the forex market will not be enthusiastic to lend money to others or even save their own money. Interest rates of various currencies and amount of money borrowed are always changing in forex market where different types of trading loan gives out different interest rates. Because of this reason, it is very important that a forex trader have an understanding of the reason for interest rate fluctuations and changes.
HOW FOREX INTEREST RATES ARE DECIDED
SUPPLY AND DEMAND
The supply and demand of currencies are determined by interest rate levels; a rise in the demand for a currency will commensurately upraise its interest rates, while a fall in the demand for a currency will produce a fall in interest rates. Correspondingly, a rise in the supply of a currency will increase them. An increase in the amount of money available to borrowers will raise the supply of the currency. For instance, when a forex opens a bank account, he is in reality, lending to the bank. The bank might utilize that money for investments and other business endeavors (a certificate of deposit will afford a higher interest rate than a checking account with which you might access the funds anytime you please). The bank can loan the money to other forex traders. More credit rushes into the economy the more the bank lends out the money. As the supply of a particular augments, the cost of borrowing (interest) decreases.
Inflation also have a way of affecting interest rate decisions. In this case, the higher the inflation rate of a country, the higher the interest rate of the country’s currency while the lower the inflation rate of a country, the lower the interest rate of the country’s currency. This is basically because money lenders will ask for an increased interest rate as compensation for the decrease in procuring power of the money/currency.
A countries government has a say on how a currency’s interest rate is affected. One of the governing body of the United States interest rate is called the Federal Reserve who have the function of making announcements on how monetary policy affects interest rates. The Federal fund rate which is also called the rate at which organizations charge one another for short term loans and how they affect the various interest rates that banks set on the amount of money they loan. The Federal Reserve have a major deciding factor over the open forex market transaction and this is done by purchasing and selling of formerly issued United States currencies.
In conclusion, interest rates are great forms of income a forex trader can earn simply by lending money but it is very important that forex traders understand how interest rates of currencies can fluctuate before engaging into it.
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