The Relationship Between Interest Rates and Currency Strength Interest rates play a crucial role in determining the strength of a currency in the forex market. Generally: Higher interest rates → Stronger currency Lower interest rates → Weaker currency 1. Why Higher Interest Rates Strengthen a Currency Attract Foreign Investment: Higher interest rates offer better returns on deposits and bonds, attracting foreign capital. Increased Demand for Currency: Investors must buy the local currency to invest in its assets, increasing its value. Lower Inflation: Higher rates help control inflation, preserving purchasing power and boosting confidence in the currency. 2. Why Lower Interest Rates Weaken a Currency Capital Outflows: Investors seek better returns in higher-yielding countries, leading to selling pressure. Increased Money Supply & Inflation: Lower rates encourage borrowing and spending, potentially devaluing the currency. Reduced Investor Confidence: A central bank cutting rates may signal economic weakness, discouraging foreign investment. 3. Market Expectations & Currency Movements Currency traders anticipate future rate changes, often driving exchange rates before actual rate moves occur. If a central bank hints at future rate hikes, the currency may strengthen in advance. If unexpected rate cuts occur, the currency may drop sharply. Exceptions & Other Influencing Factors Global Economic Conditions: If a country has high interest rates but political instability, its currency may still weaken. Safe-Haven Demand: In crises, currencies like the USD and JPY may strengthen even with low rates due to investor risk aversion. Inflation vs. Real Yield: If inflation outpaces interest rates, a currency may weaken despite higher nominal rates. Conclusion Interest rates are a major driver of currency strength, but global economic trends, inflation, and risk sentiment also play key roles. Would you like a visual representation of this concept?