The Importance of Understanding the Interest Rate

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As we all know that the fundamental economic factor has a significant influence in the currency price whilst interest rate of a particular currency is the main factor in the fundamental analysis which determines the perception of the currency. That’s why it’s important to understand how a Central Bank of particular country regulates its monetary policy by determining interest rate. This policy has a significant impact to the price stability or inflation within that country.

What is inflation? Inflation is an absolute rising price of commodities and services. We can typically understand that the inflation goes in line with the economic growth, but if the inflation is too high, it will harm the country’s economy. Central Bank has the authority to guard and supervise the economic indicators which are related to inflation, such as: Consumer’s Price Index and Personal Consumption Expenditure (CPE).

When the interest rate is being increased, the economic growth will go slowly and the overall inflation level is lower. People are more likely to save their money and reduce their loan and consumptions. If the interest rate is being decreased, consumers and businessmen increase their loan and consumptions. This means the economic sector grows.

In relation with forex, interest rate has an important impact. It’s because the interest rate will globally determine the overall capital flow inside and outside the country. In other words, investors will depend on the information of interest rate to decide whether they will invest or not in particular country.

The market condition is always changing, in relation with dynamic situations all around the world, especially in economics and politics matter. It goes the same way with interest rate that will always move dynamically, even though it’s not as fast as the market condition. If the declining interest rate has been occurring for a long period, it could possibly reverse and rise up.

Difference from the interest rate that usually goes in line with monetary policy, the market sentiment can suddenly change by the release of new report or economic news. This possibly makes significant changes in the interest rate.  There are many traders use trading strategy by comparing a particular currency interest rate with other currency as the beginning point to determine if the currencies will get stronger or weaker. A big market reaction may possibly occur when those two different interest rates from different currencies go in the opposing way.

Broadly speaking, there are two possibilities when people talk about interest rate: a nominal interest rate and a real interest rate. A nominal interest rate is an interest rate that is released before an adjustment that includes inflation factor. It’s usually released in a clear digit and stated as the interest rate (such as bank interest rate or obligation). A real interest rate = (nominal interest rate) – (the expected inflation). Investors will pay much attention on the real interest rate to decide their action, instead of the nominal interest rate. By knowing this difference, you can use this information as your consideration factor to make decision for your trading.

Happy trading in PAMM Investments !

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