Interest rates: the one factor that
traders must always keep in mind

If you're wondering what is the main factor that influences currency price variations, the answer is: interest rates. The eight most influential central banks in the world set interest rates for their country's monetary policy and influence the foreign exchange market. This rate setting - which is done periodically - is in turn the result of other economic variables. Traders who have already accumulated experience in the foreign exchange market can predict these changes and realize profits. Let's take a closer look at the impact of interest rates on the foreign exchange market.

What are interest rates?
When we talk about the interest rates that influence the Forex market, we are referring to those determined by central banks. In turn, banks and financial institutions in each country adjust their rates to these definitions.

Before delving into the concept of interest rates, let's review the most influential central banks:
     Federal Reserve (FED)
     European Central Bank (ECB)
     Bank of England (BoE)
     Bank of Japan (BoJ)
     Swiss National Bank (SNB)
     Bank of Canada (BoC)
     Reserve Bank of Australia (RBA)
     Reserve Bank of New Zealand (RBNZ)

How do central banks set rates?
The governing bodies of each central bank have a regular schedule of meetings. These meetings define the monetary policy orientations for the coming period. Among their powers is the ability to change the interest rate.

We refer to the short-term interest rate. This is the interest that banks pay to lend money to each other.

Before changing interest rates, central banks take into account other variables that influence the decision to be made:
     Consumer price index (CPI).
     Consumer spending levels
     Unemployment rate
     Movements in the subprime market
     The state of the housing market

A central bank typically takes the decision to raise the interest rate when the economy is overheated. This occurs when consumption increases. Prices increase and the credit level is high.

If a country's monetary institution decides to lower interest rates, it seeks to stimulate the economy. By lowering interest rates, it aims to encourage individuals to take out loans for consumption. Companies, on the other hand, will be able to borrow to increase their production. This is hoped to stimulate consumption and move a stagnant economy.

The art of predicting interest rate movements
Currency traders pay special attention to interest rate movements.

Based on a correct analysis of indicators that may trigger a change in interest rates, traders prepare their operation. Good fundamental analysis also allows them to anticipate the next action of central banks.

They generally take this data into account by referring to the banks corresponding to the currency pairs they will trade.

Announcements are an important aspect. After each meeting, the leaders of a central bank publish a statement or hold a press conference. For traders, this is the time to make decisions in the foreign exchange market.

It is important to take into account the long-term impact of interest rate movements on a currency. A rate hike can make a currency more attractive to foreign investors, causing its price to rise. On the other hand, a rate cut can reduce demand for a currency, causing its price to fall.

The main analysts are used to publishing their forecasts on the evolution of interest rates. Specialized media such as Bloomberg also devote significant space to these projections. This is how a consensus is established. For traders, it is important to pay attention to what the consensus says.

Lastly, some leading central bankers often state their personal position before each meeting. However, these positions often express the majority opinion.

When rates move, the entire foreign exchange market is affected.
If a change in interest rates takes you by surprise, don't worry. You have already accumulated the elements to know how the course of the currency will evolve.

Your experience tells you that if a central bank raises interest rates, the currency will appreciate and there will be a buying flow. Traders will be mostly long for this currency.

Now, if the central bank decides to cut interest rates, most traders will go long, the price will drop, and many will go to the pairs where the currency is rising.

You already know this, but you have to act very quickly. The foreign exchange market reacts instantly to changes in interest rates. Especially when it comes to the most influential central banks.

As we have already mentioned, not all changes cause large-scale currency movements. This is also something you need to be aware of as a trader. The initial momentum resulting from a change in interest rates may begin to fade over time. Momentum is lost and it's time to consider taking profits and closing open positions.

The most influential central banks in the foreign exchange market
The role of central banks in the economy and finance is crucial. They are responsible for the monetary policy of a country - or region - and the stability of the financial system. In most countries, they are an organ of the state, but retain their independence from other branches of government. This is to ensure the continuity of monetary policies, regardless of the political party in power at the time. Not all central banks have the same influence on the global economy and finance through their decisions. There are 8 institutions whose decisions impact global markets.

What role do central banks play?
Central banks differ from other commercial and investment banks in that they do not aim to be competitive entities, nor to position themselves in the market.

The main mission of a central bank is to ensure, through its monetary policies and decisions, the stability of the financial system and the performance of the economy. Among its main concerns, we can cite:
     Ensuring a stable level of inflation
     Ensure an adequate level of consumption of the population.
     Preserve, through monetary policy, the level of employment.
     Promote a stable credit system focused on the production of goods and services.

We have already mentioned interest rates as one of the main tools of central banks. Thanks to them, the monetary entities of each country can ensure their objectives.

If the economy is "overheating", meaning inflation levels have exceeded the bank's targets, intervention may be necessary. To do this, the central bank raises interest rates. An increase in the price of silver will limit credit and consumption.

Conversely, if the economy is depressed, consumption and inflation are below expected levels, there will also be intervention. Lowering interest rates may be an alternative. This encourages credit, both for production and for the purchase of goods. The economic cycle is reinforced by the central bank.

The influence of central banks on foreign exchange markets
Central banks, as monetary policy makers, have a decisive influence on money. Therefore, the final impact of a central bank's decisions can be measured in the foreign exchange market.

Of course, the influence of monetary institutions is not always of the same magnitude. Not all banks have the same power of influence. Consider this: the most traded currency in the forex market is the dollar. We can already deduce that the Federal Reserve system - the US central bank - is the most influential in the world. Every decision he makes has an impact on most forex trading.