Many fundamental factors determine the supply and demand of a particular currency and value against other currencies. These factors are a ratio of interest. Central banks are the institutions that set base rates in a country and modify their levels to streamline the development of the local economy. The increase in the interest rate will result from the value of the value of the nation’s currency while reducing the ratio of interest should have the opposite effect, respectively.
In general, interest rates initially affect various government bonds, including bond yields, creating the demand for currency in which these obligations are denominated, resulting in an appreciation of the local currency. Economic theory presupposes such behavior of market players, although they often behave differently and under the influence of other factors. Sometimes the investor will seek a safe refuge, regardless of the fact that interest rates are high in their country because they do not believe in the local economy or consider exchange rates as unfavorable in the long term.
The interest ratio also influence the whole economy; Determine the cost of loan and borrowing money, create a lower or higher supply and demand, respectively. A factor that you should consider when the material is high of nominal interest rates is the level of inflation. A high inflation rate can compensate for the high interest rate.
An interesting phenomenon in relation to interest rates is that the foreign exchange market is very often motivated by the perceptions and future interest forecasts instead of the actual levels set by central banks. Therefore, when mass forex dealers believe that interest rates in a given country might fall, they could begin to sell the mint of the nation, regardless of the fact that all fundamental indicators send positive signals.
All of these factors are important, but only in the situation of a free currency and an open economy, that is, not of excessive trade and investment restrictions and lack of restrictive exchange regulations. If these conditions exist, the exchange rate will be influenced by the evolution of interest rates and will appreciate and depreciate accordingly. On the other hand, countries offering the highest returns on their obligations are not very predictable and their obligations generally carry a higher risk for investors. Therefore, the first alarming signal relating to this country will urge investors to discuss their investments and the value of currencies will immediately fall, resulting in less advantageous exchange rates against the main global currencies.