Economic Indicators and Their Impact on Currencies

In this video you will learn:

• How different economic indicators affect a currency?

We will discuss the following economic indicators:
1. Interest rates.
2. Inflation.

Interest rates:

Economic indicators measure how strong an economy is. It is important to understand how strong an economy is. The strength of an economy has an impact on the price of a currency. These indicators are released as reports and the publishing times are released ahead of time. Interest rates are one of the most important drivers of the currency markets. They are normally set by a country’s central bank. For the United States, the interest rates are set by US Federal Reserve bank. And for the Eurozone, it’s the European Central Bank. The central banks use the interest rates to promote the economic growth, or to curb inflation.

The central bank of a country lends money to commercial banks and the interest rate set by the central bank is what the commercial bank has to pay for borrowing the money. This is referred to as the base interest rate. These commercial banks also lend money to people who want to buy things such as a house. The minimum interest they have to pay is the minimum based on the interest set by the central bank. When the central bank increases the interest rates, the cost of borrowing goes up. This means that the homeowners have to pay more their mortgages. So, the demand for goods like cars will go down. Raising interest rates will curb the economy by decreasing the demand for goods and services and will reduce inflation.

However, when the economy is not doing so well, the central bank wants to decrease the interest rates to stimulate the economy. Now, when the interest rates are lower, the home owners spend less on mortgages and therefore has more money to buy other goods and services like cars and increase demand for goods. So, production rises and thereby stimulate economic growth. When the interest rates are low, the cost of borrowing is low. Business owners will be more inclined to grow their business and will therefore borrow money. This money is invested in the economy promoting the growth. When interest rates rise, business owners will not invest much and the economy will slow down. Higher interest rate means you get a high rate of return for the money you hold in your savings account. If one country has higher interest rate than another country, money will flow into the country with higher interest rate. Because investors will get more interest on their money.

Inflation:

Inflation measures the rate at which prices of goods and services rise in a given period. If inflation is too high, prices increase significantly and therefore reduce the purchasing power of the money. It has a negative effect on the currency. If a country experiences low inflation, prices become stagnant or rise slowly. Investors could see this as an indication that the economy is not as strong. Therefore, it could have a negative effect on the value of the currency. Central banks tend to raise interest rates to protect consumers from excessive inflation. It reduces the spending power of the consumers and a reduced demand for goods and services, thereby keeping the price at an optimal rate. The terms “hawkish” and “dovish” refer to how the central bank manage the balance between inflation and growth. If the central bank is concerned about inflation, it is considered hawkish. And is more likely to adopt a higher interest rate. If the central bank is concerned about growth, it is considered dovish and is more likely to adopt lower interest rate.

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