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Old 05-31-2009, 12:58 AM   #1 (permalink)
 
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Interest rate effects on currency


hi

i wanted to ask about interest rate cuts and increases, as i dnt understand how a currency behaves when the interest rates move.

bank of england and european central bank are expected to annonce new interest rates on thursday, and during the last 2 times BoE cut its interest rates, it instanly moved the GBP/USD by about 100 pips up.
that means it strenghted the pound, but i alwas thought that interest rate cuts weaken a currency?

i just wanted to know would a currecy always go up if the central bank announces a interest rate cut?
and would a currecy pair go down if the central bank increases the interest rate?
and what would happen if the interest rate is announced to stay the same?


if you get this right it can be a easy for for new traders to make easy bucks by just trading interest rate increases and decreases.

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Old 05-31-2009, 01:09 AM   #2 (permalink)
 
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Quote:
Originally Posted by shaby View Post
hi

i wanted to ask about interest rate cuts and increases, as i dnt understand how a currency behaves when the interest rates move.

bank of england and european central bank are expected to annonce new interest rates on thursday, and during the last 2 times BoE cut its interest rates, it instanly moved the GBP/USD by about 100 pips up.
that means it strenghted the pound, but i alwas thought that interest rate cuts weaken a currency?

i just wanted to know would a currecy always go up if the central bank announces a interest rate cut?
and would a currecy pair go down if the central bank increases the interest rate?
and what would happen if the interest rate is announced to stay the same?


if you get this right it can be a easy for for new traders to make easy bucks by just trading interest rate increases and decreases.
Hi Shaby,

When a central bank cuts or increases rates, they are literally increasing or decreasing the money in circulation respectively. Common wisdom says that rate increases tend to strengthen a currency because the currency is higher yielding now as to before. There is a carry trade strategy that some traders use. By using the differential of each currency's yield, traders make a profit from buying the currency with a higher yield and selling that of a lower yield.

In these times of economic volatility, its often more important to understand why rates are raised and lowered. As you said the pound strengthened when the BoE cut rates. That might be due to commentary following the rate cut.

I want to say that thinking about trading rate decisions is a risky business and i DON'T recommend anyone do that. Furthermore, trading is about consistent profits and not one big fish once in a while.

Hope this helps

Forexer
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Old 06-05-2009, 03:08 PM   #3 (permalink)
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Hi shaby

How are you?

Like forexer said, in general, increasing an interest rate usually causes money to flow into the country for fixed income investments, which causes the currency to strengthen.
Cutting interest rates causes a currency to get weaker because money will flow out of the country looking for better returns elsewhere.

As you can see with the GBP, that is not always the case though.
For the Pound, the cutting of rates was a sign that the government was attempting to improve an economy falling hard, the rate cut caused a rally (With the theory being that the rate cut would help improve the economy, and bring back some of the money that left when the economy started downhill, offsetting the money that leaves for better returns elsewhere).

Quote:
"what would happen if the interest rate is announced to stay the same?"
The big factor would be, and this applies to when they raise or lower interest rates as well, is what the consensuses thought would happen. If the 'experts' thought that the interest rate was going to be cut 1/2 point, and they do nothing, things will react a lot more than if the 0 cut was estimated ahead of time.

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Tek
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Old 06-05-2009, 05:25 PM   #4 (permalink)
 
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ok got it, but i dnt understand why on thursday when BoE and europe central banks announced that rates will stay unchanged there was a delay in the rally, for the first 30 minutes when BoE announced its rate unchnaged price was at the same levels for the first 30 minutes and suddenly it went bang and droped down, the same thing happened later with the euro when the rates were announced unchanged by the european central bank. Did the hedge funds and investment banks wake up late that day

btw. i was comparing GBP/USD and EUR/GBP
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Old 06-08-2009, 09:53 PM   #5 (permalink)
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Hi shaby

I do not know specifically.
There could have been other things in the news that caused this. Gordon Brown is in hot water for one thing.
Also, if the interest rate announcement is what was expected, sometimes price won't react much.

Cheers
Tek
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Old 06-09-2009, 12:27 AM   #6 (permalink)
 
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Quote:
Originally Posted by Tekmnd View Post
Hi shaby

I do not know specifically.
There could have been other things in the news that caused this. Gordon Brown is in hot water for one thing.
Also, if the interest rate announcement is what was expected, sometimes price won't react much.

Cheers
Tek
I am not sure on this but I think it was because the market were expecting EUR central bank to hint at a rate cut.

Nothing was immediately clear and it took a while for the market to take in the lack of such an announcement with the resultant bounce in EUR (that caught me out quite badly with worst slippage I have yet experienced)

Graeme
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