FOREX INTEREST RATES
In The forex market when you make a transaction you are effectively borrowing one currency to purchase another.
Interest rate differentials are a useful source of profit in long term forex trading. The difference between the currency you are borrowing and the currency you are purchasing is a profit that is made irrespective of the direction the pair moves in the forex market.
Buying GBP/USD is in effect borrowing USD at 4.5% and purchasing GBP at 5.5% if those were the current interest rates. You would earn 1% interest times your leverage 100:1 will give you a 100% return per annum. Substantially more than what any bank would offer. This of course would work perfectly if interest rates were the only factor affecting the forex market unfortunately there are many other factors affecting the forex market.
The carry trade is a popular example of this working for extended periods of time in the forex market. The Japanese Yen has been pushed lower during the last few years due to a variety of factor and the fact that the interest rate has been close to zero made it a perfect target to make money of the interest rate differentials in the forex market. The New Zealand dollar has a high interest rate and has been appreciating strongly over the last couple of years in the forex market. Combining this pair NZD/JPY has made many traders a fortune. How long this will last is anyone’s guess.
The interest rate is just another factor in the valuation of a currency. A higher interest rate implies a stronger currency and vice versa.