A key factor that influences the foreign exchange (forex) market is the interest rate changes made by major central banks such as the Federal Reserve of the United States, Bank of England (BoE), and the European Central Bank (ECB). The changes in interest rates are carried out as part of their monetary policy in response to a number of economic factors including inflation and growth.
The interest rate changes can sway the forex rates instantly, and at times — substantially. Since these changes tend to influence the currency exchange rates, it is vital to understand them to make higher gains in forex trading.
Impact of interest rate changes
When the interest rates are hiked, the forex traders want to buy the currency and its exchange rate rises. On the other hand, when the interest rates are cut, the traders want to offload the currency, which leads to a decline in its rate. If a thorough and timely research is done prior to the movement of interest rates, a trader can save themselves, in most cases, from sudden exchange rate changes.
Although interest rates can be anticipated with the aid of right economic models, the surprise statements by a big central bank, at times, leave the forex markets in a tizzy. The forex traders know that despite having done incisive research or number crunching on projected interest rates, central banks can still give a surprise rate cut or hike. When the currency rates move, traders can maximise their profits from volatility in the market.
So, it is pertinent to know that foreign exchange rate of all major currencies is invariably influenced by announcements made by major central banks including the Federal Reserve and European Central Bank (ECB).
But it is equally important to know that the announcements are the reflection of major economic factors prevailing in the economy during that time. The conventional wisdom demands that staying abreast of those macro factors is as important as the central bank announcements that encapsulate them.
Currency exchange rates tend to change as central banks determine monetary policy in their respective regions. Traders have the ability to maximize profits as currency rates move. The potential profit exists not only in the interest of the carry trade, but also in the actual fluctuation of the market. In-depth research and analysis can help traders seize opportunities when unexpected interest rate moves inevitably occur. Therefore, for day traders, tracking major news events and analyzing central bank actions should be the top priority of forex traders.