Interest rates affect forex in that they shape how a currency’s value is perceived. Higher rates usually mean increased demand for that currency, causing people to buy more of it. Therefore, any change in the interest rate will impact forex, meaning forex traders should always be aware of when their national central bank’s interest rate announcements occur.

Forex traders who are prepared will understand where rates are expected to go, and factor this likelihood into their decision-making. For example, if rates are likely to shift at the end of a monetary cycle within, say, a month’s time, a longer-term position trader will need to consider if a trade opened immediately will be affected by this fundamental event down the line.

How interest rates are calculated

Interest rates are calculated via central banks’ board of directors. Rates can be hiked to curb inflation and cut to encourage lending in the economy. Economic indicators that can give clues as to the direction of interest rates include the Consumer Price Index, the condition of the housing market, employment statistics, and consumer spending, so these are all worth keeping an eye on for those trading forex.

Forex interest rate carry trades

A forex interest rate carry trade is where a trader borrows or sells a low interest rate currency in order to purchase another currency with a higher interest rate. Carry trades may be popular where the interest rate spreads between the two currencies are high. This is because paying a low rate on the borrowed currency potentially allows for a return on the higher rate of the purchased currency. In simple terms, if you go long on a pair like AUD/JPY, where the Australian Dollar has a higher interest rate than the Japanese Yen, you are making a carry trade. In effect, the broker will be paying the interest rate differential between the two currencies, minus the spread.