Why Interest Rates Matter

Why Interest Rates Matter

By: Jon Beddell

Markets can be volatile, or to put it another way, fickle! One of the main drivers behind currency movements are interest rates. Each economic area has its own central bank which sets interest rates according to its outlook for growth and inflation.


The aim of monetary policy is to walk a tight rope between stimulating growth, and staving off inflation. All other things being equal, demand for each currency is largely dependent on these relative interest rates, as investors from around the world move money around in search of the best return.


For example, the central bank rate in New Zealand is 8.25%, which means there is plenty of demand for the currency. By contrast, the yen offers just 0.5%, and until recently has been very weak against other major currencies as investors attempt to exploit this difference by making so called carry trades (borrowing in one currency with low interest rates and investing the money in another currency with a higher interest rate).


More relevant to anyone buying a property abroad over the next year is how interest rates are having a negative effect on the pound. When the credit crunch became big news in the summer, the US Federal Reserve acted quickly to cut interest rates. As it did so, investors naturally dumped the dollar in favour of other major currencies whose interest rates were not falling, namely the euro, and to a lesser extent the pound. The euro/dollar and sterling/dollar exchange rates rose sharply as a result.


Since then it has become increasingly apparent that the Bank of England will also cut interest rates in the next couple of months. Investors now have good reason to add sterling to their list of currencies to be avoided, especially while uncertainty remains over the timing of any cut.


Meanwhile, the European Central Bank are keeping rates on hold, with no clear indication of any rate cuts in the pipeline, making the euro a relatively safe bet in the short term. So in summary, the relative allure of the Euro has grown as the interest rate advantage of holding sterling or dollars has diminished.


Of course, for anyone buying dollars, the extreme weakness in that currency means you can still get a great exchange rate!

This article is brought to your by http://www.TorFX.com, Specialists in foreign currency exchange. For the latest foreign currency exchange rates visit http://www.TorFX.com

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