The economic health of a country and the value of its currency are intrinsically linked, so, as a forex trader, you’ll need to keep up to date with the latest economic updates and data releases. You can do so using an economic calendar, upon which all of the most influential political and economic events are plotted. By planning ahead in this way, you can intercept and plan ahead for any changes in value that your trade could incur, maximising your chances of profiting and minimising the risk of making losses.
If you’re wanting to invest in the foreign exchange (forex) market, Plus500 explains what forex is – describing it as:
“The trading of currency pairs, and can be defined as the simultaneous purchase of one currency against another. Forex takes place mainly on the OTC market; however, it is also traded on futures exchanges”.
There are many economic factors that can affect forex trading, with one of the most significant being changes in interest rates. In December 2021, the Bank of England increased the UK’s most influential interest rate — the Bank Rate. This was raised from 0.1% to 0.25% and in this article, we will take a look at why the UK’s central bank has done this and explore how it could affect forex trading.
Why have interest rates increased?
Inflation and interest rates are closely connected and the world’s central banks can manipulate interest rates in order to influence the rate of inflation. In fact, the Bank of England increased the UK’s interest rates so significantly in December, to maintain the country’s target inflation rate of 2%. Inflation has been increasing as a result of the coronavirus pandemic, which has significantly weakened the UK’s economy. The Bank of England expects that:
“The inflation rate will reach around 6% in the spring. But increasing interest rates now will help make sure inflation falls back to our 2% target by the end of 2023.”
Increasing interest rates is typically a successful method to control the rate of inflation, but it also can have significant consequences for the country’s residents. Higher interest rates mean that it’s more expensive to borrow money and individual’s savings can also be affected. Overall, living costs will increase and the consumer will typically have less money to spend upon non-essential goods, subsequently weakening the economy.
How could forex trading be affected?
A change in interest rates can drive forex prices and therefore, have a marked influence upon the landscape of the forex market. This is because higher interest rates will attract investment from other nations, which will subsequently boost the demand for their currency, seeing it increase in value. Therefore, the Bank of England’s increase of interest rates could impact pound Sterling (GBP) currency pairs and also currency pairs involving the Euro (EUR) since this currency is closely correlated to the pound.
Each nation will release their interest rates periodically, since it is included in their consumer price index. This is a data release that is plotted in an economic calendar, and therefore you can plan ahead and utilise technical data to examine the currency’s past performance to help you to make predictions about future price movements.
What other factors can affect forex?
The forex market is highly volatile and currency pair prices are therefore extremely susceptible to change. Currency’s values can be influenced by a variety of external factors and these include:
- Geopolitical and macroeconomic events
- Employment rates
- Gross domestic product (GDP)
- Federal funds rate (FOMC)
Any event or data release that could impact the economic health of a country could have a subsequent effect on the forex market. For example, a political event like an election could affect the forex market because elections are surrounded by uncertainty – particularly if the vote is delayed or contested. This can cause traders to adjust their position if they believe that the election may affect the value of the nation’s currency.
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Since the forex market is so volatile, you will need to keep up to date with news releases, use a combination of fundamental and technical analysis, alongside risk management tools to protect your capital. By doing your research and having a developed understanding of the market and what can affect it, you can put yourself in the best position to profit in the forex market.
