If you are a newbie forex investor and you find that the movements in the currency prices are becoming a bit too boring fro your own taste, then you should probably wait for some major announcements in the interest rates by some central banks.

Interest Rates: The Great Movers

There is no economic news that is released regularly that carries much weight as interest rate announcements. And this type of economic release usually creates some sizeable movements in currency pairs involving that nation’s currency. And this is especially true whenever there is so much expectations building up on the market whether favorably, or otherwise, for an interest rate change.

The Interest Rate Effect On Nations’ Currencies

But why exactly are interest rates crucial in the prices of a nation’s currency?

For those of you who are more familiar with stock market trading, here is a practical analogy for you.

A company’s stock usually increases in value whenever the said company declares that it would give dividends to its shareholders. Whether it is a cash dividend or a stock dividend, it does not matter much because what matters is that it means that in the near future, anyone holding on to that company’s stock would receive the dividend as a share of the profit for the company’s earnings.

Now, imagine the company’s stock as a nation’s currency. The way that a person holding that nation’s currency to earn from it, without necessarily investing it in any business or trading investment, is through interest earnings when he or she places it in a bank. A thousand dollars that you put in a bank today would earn some interest earnings when you withdraw it from the bank one year from now. We can view interest rates as like a company’s dividends. Just as dividends are promises of a share in the company’s earnings for anyone holding that company’s stocks, interest rate effects are promises of growth in earning for anyone holding on to that nation’s currency.

When a country’s Central Bank announces that it is raising its interest rates, it is as if a company is announcing an increase in its dividends for its shareholders. Investors would want to hold on to something that would give added value in the future. And if investors demand for a particular stock or currency, it results in the price of that stock or currency to rise. That is the simple law of supply and demand.

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