Interest rate increase and currency levels | Forex Factory

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Interest rate increase and currency levels

  • #1
  • First Post: Dec 8, 2006 8:45pm Dec 8, 2006 8:45pm
on 12/07, the ECB raised interest rates by .25%. I understand that increasing rates has a positive effect on the nation's currency as it makes that currency more valuable. However, I couldn't help thinking that if interest rates are higher, the economy should slow down as that's the main purpose of raising rates is to control inflation. This notion contradicts each other has if the cost of money is higher, how can businesses profit and in the end, how can currency be up if businesses are not profiting?

Are short term raising interest rates bad for currency and when the economy catches up with the new higher rate, and continues to prosper higher, then a higher rate will be needed again so it's like a cycle? So looking at the long term, a raising trend of continous higher interest rates is good for the economy but right when the interest rate hike is released, the nation has to adapt to it?
  • #2
  • Dec 8, 2006 8:58pm Dec 8, 2006 8:58pm
when interest rates go up, people around the world want to invest more in that country (cause they get a higher rate of return on their cash). so they convert their money into the country's currency so they can invest (because ya cant use euros in japan ). when they convert their money they are buying the new currency and selling their own currency. this is why interest rates move currency values. there is more to it, but this is the foundation.

hope this helps
Relax and be happy.
  • #3
  • Dec 9, 2006 9:15am Dec 9, 2006 9:15am
Quoting merlin
when interest rates go up, people around the world want to invest more in that country (cause they get a higher rate of return on their cash). so they convert their money into the country's currency so they can invest (because ya cant use euros in japan ). when they convert their money they are buying the new currency and selling their own currency. this is why interest rates move currency values. there is more to it, but this is the foundation.

hope this helps
thanks for the response, however, if interests go up for that country, the exports will be affected as it costs more to buy the same product with higher interest rates, the nations business will be affected as the "cost of money" is higher now. So as a whole, how can these factors be good for the nation's economy with higher interest rates?

I understand the fact that converting currencies for a higher rate of return but how can the value of currency go higher if increasing rates affects the economy in a bad way?
  • #4
  • Dec 9, 2006 9:28am Dec 9, 2006 9:28am
sure, selling less imports leads to a worse trade balance. and this has a negative effect on th economy. but the thing is, currencies dont move because of the economy. the only reason currencies react to economic-health indicators (ie trade balance, gdp, industrial production) is because the health of the economy affects inflation, and inflation affects interest rates. ITS ALL ABOUT INTEREST RATES.

check out this thread, i explained about "the path"...
http://www.forexfactory.com/forexfor...d.php?p=137964
Relax and be happy.
  • #5
  • Dec 9, 2006 9:35am Dec 9, 2006 9:35am
Quoting merlin
ITS ALL ABOUT INTEREST RATES.
That's going in my Signature, so I never forget...
  • #6
  • Dec 9, 2006 10:26am Dec 9, 2006 10:26am
Quoting merlin
sure, selling less imports leads to a worse trade balance. and this has a negative effect on th economy. but the thing is, currencies dont move because of the economy. the only reason currencies react to economic-health indicators (ie trade balance, gdp, industrial production) is because the health of the economy affects inflation, and inflation affects interest rates. ITS ALL ABOUT INTEREST RATES.

check out this thread, i explained about "the path"...
http://www.forexfactory.com/forexfor...d.php?p=137964
ahhhh! The missing link. Economic data ----> Decision on Interest Rates ----> currency value.
  • #7
  • Dec 9, 2006 12:00pm Dec 9, 2006 12:00pm
Quoting smjones
That's going in my Signature, so I never forget...


once you know its all about interest rates, its like this big complex puzzle starts to actually make sense. all the little things you see, like how the market reacts to a cpi number, or how they react to bernanke talking, you start to see how all these little peices fit in to the bigger picture.

btw this is not my invention, i have learned this way of looking at currency fundies from the best traders in the world. they didnt teach me personally, but over the years you get bits and peices and you figure out this is how it's done.
Relax and be happy.
  • #8
  • Dec 9, 2006 12:03pm Dec 9, 2006 12:03pm
Quoting Trader1580
ahhhh! The missing link. Economic data ----> Decision on Interest Rates ----> currency value.
just make a "path" for each economic event and youll understand how it effects the market. sometimes the path can be very long though, like 6 or 7 links in the chain. the more links, the less it probably effects the market. thats why inflation is such a big deal, its only one link away...

stronger economy = higher inflation = higher interest rates
Relax and be happy.
  • #9
  • Dec 9, 2006 12:18pm Dec 9, 2006 12:18pm
Quoting merlin
just make a "path" for each economic event and youll understand how it effects the market. sometimes the path can be very long though, like 6 or 7 links in the chain. the more links, the less it probably effects the market. thats why inflation is such a big deal, its only one link away...

stronger economy = higher inflation = higher interest rates
yep, I can "feel" it already. If the fed cut rates, they will try to let the economy improve by letting business have a cheaper "cost of money" so they will begin to improve, and if they continue to, maybe they will raise rates later.

Merlin, in your opinion, can you rank the different economic indicators in terms of improtance for inflation? Example, I'd imagine unemployment change and unempolyment rate is on the top.

thanks for all the heads up
  • #10
  • Dec 9, 2006 12:32pm Dec 9, 2006 12:32pm
I would think CPI, because it is a direct measure of inflation and if there is inflation interest rates must go up.


Quoting Trader1580
yep, I can "feel" it already. If the fed cut rates, they will try to let the economy improve by letting business have a cheaper "cost of money" so they will begin to improve, and if they continue to, maybe they will raise rates later.

Merlin, in your opinion, can you rank the different economic indicators in terms of improtance for inflation? Example, I'd imagine unemployment change and unempolyment rate is on the top.

thanks for all the heads up
  • #11
  • Last Post: Dec 9, 2006 4:00pm Dec 9, 2006 4:00pm
Quoting smjones
I would think CPI, because it is a direct measure of inflation and if there is inflation interest rates must go up.
yep, CPI/PPI are among the top. Also, trade balance, hourly wage, is particular interesting right now
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