Understanding Interest Rate Influence On Forex Market

Forex traders around the world are waiting for the last US Federal Reserve interest rate announcement for the year on Tuesday, December 11, 2007 at EST 1415hrs. Most Forex market traders are anticipating at least a quarter point cut from the current 4.5%.

Interest rates are simply defined as the amount of money a borrower must pay to a lender in order to hold their money. The lender provides money to the borrower which is the bank and in return, after specific time duration, will receive interest in conjunction with the original sum he or she lends.

For newbie entering the Forex market arena, you may not fully understand how significant this decision can affect the foreign currency market. In reality, interest rates play the most important role in moving the prices of currencies in the Forex market. A country interest rate dictates the flows of money. As currency represents a nation's economy, differences in interest rates affect the relative worth of currencies in relation to one another

When a country's central bank raises their interest rates, naturally, investors will want to capitalize on the higher interest rate returns by shifting money and asset into the country. Hence, as a country interest rates rise, their currency is seen as being stronger than other currencies. An increase in interest rates encourages traders to invest within that market and causes the demand for the currency to rise. As demand rises, the currency becomes scarcer and consequently more valuable.

Up till now, the whole discussion is focus on what will happen if a nation's central bank raises its interest rate, but what if the central bank decides to lower their interest rate? Take the above scenario, if Fed decides to further lower their interest rate, US dollar will weaken. But will it falls further against other major currencies? The outcome is unknown as only the Fed will know by many basis points they decide to lower. If this time round, the cut is a mere quarter point, anything much may happen as most traders already factor in this cut. This is called "market expectation". If the US Fed decides to take a more drastic cut of 0.5% basis point, I am sure the dollar will becomes even more bearish and will continue its fall against most major currencies.

Forex Trading beginners may be wondering why the US Fed wants to continue to lower their interest rate. The US Fed has been lowering interest rates to encourage borrowing and stimulate the sluggish US economy. In Forex Trading, a major side effect of a lower US interest rate is that lower rates make dollar-denominated securities less attractive to global investors.

JoonTrader is the owner of forexdiscover.com. For further recommended resources on how to make money in Forex Trading. Click here to grab the secret to consistent pips.