The true grit is in the statement that is given along side the decision, it is scrutinized for signs of what the Fed will do before the next meeting and decision time. It is particulary important to remember, the interest rate decision itself is not as crucial as the expectations for future interest rate alterations. An interest rate is attached to every countries currency. This can be a statement of an economy's strength or current weakness.When an economy strengthens consistently, product prices also rise as people have more disposable income. When prices rise it is known as inflation, this is watched closely by the nations Central Bank. If inflation gets out of hand, a currency will lose buying power, this is what makes everyday items like a loaf of bread rise from £1 a loaf to nearer £2 per loaf.Central banks can prevent inflation from getting way out of hand and in some countries, it is called upon more often than others to prevent the danger and keep them under control. Once Inflation starts, it is difficult to stop, this is why the Fed’s keep continuous almost obsessive watch to stand against it.Borrowed money becomes more expensive when interest rates are higher, this then makes consumers think twice about things like buying a house, taking out a loan or using credit and store cards. More importanlty to the economy, when money is more expensive to borrow, it prevents and discourages corporations and businesses from expanding. Such a high percentage of businesses run on credit, and with that, interest is ofcourse charged. So the danger of high interest rates is that it can have very adverse effect on economies. In walks the Central Bank again, to lower the interest rates to encourage growth and trading once again, and this Is how the cycle evolves.It can be a very delicate affair, trying to encourage both growth and keeping inflation in check.
Encouraging Foreign Investment:
Increasing interest rates can trigger more desire for foreign investors to make investments in a country. This is the same as with any investment, where the investor is seeking the highest possible return for their money. Increasing the interest rates, the returns in turn increase for the investor. When this occurs, there will be an increased demand for that particular currency as it creates a rush for traders to invest where the rates are highest. The most foreigh capital is invested in Countries that offer the highest return on investment through high interest rates, economic growth, and growth in domestic financial markets. If a country's stock market is doing well, and they offer a high interest rate, foreign investors are likely to send capital to that country. This increases the demand for the country’s currency, and causes the currency’s value to rise.Money always follows the yield. If a country increases interest rates, it is highly likely that international interest in the currency will also increase.Functions of Capital banks and characteristics are:
- They have huge reserves of funds.
- Have specific economic goals set
- They regulate interest rates and money supply
- Set the overnight lending rates, which changes the amount of interest paid on the domestic currency
- They sell of government owned assets such as the recenty sell off of Royal Mail in the United Kingdom
- They occasionaly actively trade their own currecy in the open market to try and influence exchange rates
From reading this so far, hopefully you can clearly see that interest rates can have a massive impact on the capital flow in countries around the world.
Capital Flows – Positive & Negative
As we discussed earlier, capital flow occurs when money is sent from overseas to invest in a country’s markets. This can strongly impact a nation's currency price, as positive capital flow indicates demand for investments in a currency, whilst negative capital flow indicates weak demand verses supply.
The most important Central Banks involved in this process:
- The Bank of Canada
- Bank of England
- Bank of Japan
- European Central Bank
- The Federal Reserve (USA)
- Swiss National Bank
- Reserve Bank of Australia
- Reserve Bank of New Zealand
These banks hold regular meetings, usually on a 4 to 6 week cycle, depending on the banks in question.
You have now gained knowledge in the area of currency interest rates, Capital Flows, the Central Banks and how they can greatly impact the currency market Forex.
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