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How Does Interest Rates Affect Exchange Rates?

The vital role exchange rates playon international trades makes exchange rates especially analyzed by governments and in times of need, even manipulated. Along with interest rates and inflation, exchange rates determine the economy’s health. As such, it is significant that you know what affects the exchange rates. As a trader it is only appropriate to learn more about a currency’s exchange rate and why it has become that way.

To illustrate the role of exchange rate let us first examine how it affects international trade as this is what serves as our ties towards other countries. Basically, in international trading, there are two actions: importing or buying goods from other countries, and exporting or selling goods to other countries. Countries buy and sell the goods on their respective currencies. Then there’s exchange rates. It is the comparison between two currencies. The value of the currency will then determine how much a currency can buy or sell versus another country’s currencies.

Thus, exchange rates carry a huge significance in an economy’s health.

Interest Rates

As mentioned earlier, along with exchange rates, the other indicator of economic health are inflation and interest rates among others. These three are constantly interacting and influencing each other. That’s why differentials in inflation and interest rates affect exchange rate.

Interest rate is part of a loan that serves as interest or payment for the loan that is typically expressed in percentage.

Higher interest rates gives lenders increased returns for their loans and thus it attracts foreign investors to loan capital because of the better profit. Exchange rates also rise because of this. Lower interest rates means lower exchange rates.

Created by : Albert
Published : 16 Apr 2015

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