Interest Rate

What is an interest rate?

An interest rate, in the context that matters most to traders, is the benchmark rate set by a central bank — the price at which banks borrow and lend money within an economy. This single number ripples through everything from mortgage costs to savings returns to, crucially, the relative attractiveness of holding one currency versus another.

Why interest rates move currencies

Higher interest rates tend to attract foreign capital, because investors can earn a better return on deposits and bonds denominated in that currency. All else equal, rising rates (or the expectation of a future rate hike) tend to support a currency, while falling rates (or expected cuts) tend to weaken it.

Consider a simplified example: if one country’s central bank raises its policy rate while another country’s central bank leaves rates unchanged, capital may flow toward the currency now offering the higher return, pushing its exchange rate up relative to the other. Markets often move on the expectation of a rate change well before it happens, which is why central-bank commentary is watched as closely as the rate decisions themselves — see hawkish and dovish.

Interest rates and trading costs

Interest-rate differentials between two currencies also determine the swap — the overnight financing charge or credit applied to positions held past the daily cut-off. This same differential is the basis of the carry trade, a strategy of borrowing a low-rate currency to fund a position in a higher-rate one.

Why it matters to a trader

Interest-rate decisions from major central banks — announced through bodies like the FOMC — are routinely among the highest-impact events on the economic calendar. Even a small, unexpected change in rate guidance can trigger outsized volatility, so traders track rate-decision dates and the surrounding monetary policy statements closely when planning entries, exits, and position size.

Quick recap

• Interest rates are set by central banks and directly influence a currency’s attractiveness.
• Rising rates tend to support a currency; falling rates tend to weaken it.
• Markets react to rate expectations, not just actual decisions.
• Rate differentials also drive swap costs and carry-trade strategies.