The fundamental analysis is one of the most important elements of the analysis and forecasting on the Forex market. The technical analysis is also a powerful instrument, however, the forecasts made on the basis of the fundamental analysis are more precise and the process of the analysis will allow to go to the root of the situation at the market.

One of the most important processes affecting the movement on the market is the process of the interest rates’ change by the central banks, in most cases this leads to the activation of the market. In this article we will discuss the connection between the change of the interest rate and exchange rate.

Each state has its own interest rate policy of the central banks. When it is formed, such major instruments as the base rate and bank rate for the transactions on the financial market are used. All decisions about the change in the interest rates are taken on the assumption of different macroeconomic indices. The market is the most unpredictable in the moment when the interest rates are change unexpectedly. That is why each trader, who uses the fundamental analysis, should pay attention to the forecasts and reports. Basing on his/her knowledge the trader should make the conclusions regarding the probable behavior of the market in future. This will allow to avoid the probable losses and to use the situation for his/her benefit.

The basic concept of the interest rate

Traders, using the fundamental analysis, have to take into account the role of the interest rates. This moment is very important for the traders who work during the day. The explanation is very simple. The trader, who works on the Forex market during the day, orients on the certain amount of the profit. That is why such trader has a particular level of the intraday income. Correspondingly, the higher is the level, the greater are the sums used by the trader.

However, such type of trading should not be considered as the opportunity to earn quickly the large sums of money. It is far from true. The fundamental analysis of the Forex market is a vast science, which requires form the traders the intellectual flexibility and efficient application of knowledge. This implies that trading on the Forex market the dynamics of the market should be taken into account, since the currency fluctuations can lead either to the profit or to large losses.

How the value of the interest rate is determined?

Primarily, you should remember that the interest rate is the leverage of the Central bank on the national currency and is one of the links of the monetary policy. Every Central Bank has a Board of Directors, which takes the decision concerning the short-term interest rates. The interest on credit is determined by the short-term interest rate, which is issued by the Central Bank to the commercial banks. In case the inflation starts the Central Bank, depending on the targets, will try to influence the national currency due to the control over the interest rates. When the counter inflationary decisions are taken, the interest rates are raised. In such way, the volume of active money will be decreased and this in its turn will lead to the decline of the inflation. If the decision is taken to advance the money supply then the interest rate will be lowered.

It is impossible to foresee which decision will be made by the Central Bank. That is why the trader should study the fundamental analysis. The trader should know the economic indices, which will help to forecast what measures will be accepted by the Central Bank in regard to interest rates. In this connection it is worth to pay attention to the following indicators:

Housing Price Index

Employment rate

Consumer Price Index

Consumer Spending Index

How these data can be used?

Earlier, we have talked about the indices, which should be taken into account by the trader, using the fundamental analysis. Besides, the Central Bank can take into account other data also, however, the indices which you can see above are the base. That is why the traders have to follow their dynamics. If the indices improve then the economy develops normally. In this case the level of the interest rates is unchanged, or it is increased partly. If the readings of indices worsen than the level of the interest rates declines. In such way the amount of funds, which are in circulation, increases.

What should the trader do when the level of the interest rate changes?

Very often the forecasts can be mistaken, because the measures taken on the control over the interest rate can be unexpected. That is why each trader should carefully study the fundamental analysis in order to know what to do even in cases of force majeure. At first, the trader should remember that in case the interest rates are decreased unexpectedly, then the bulk sale of currency is possible. This is connected with the fact that the majority strives to protect themselves against the possible losses.

Conclusion

The fundamental analysis of Forex market is a complicated system, which consists of different indicators. Nevertheless, despite the fact that it is almost impossible to study all details of the fundamental analysis, the knowledge of the basic factors is necessary for the successful trading on the international Forex market. The interest rates are one of the bases of the fundamental analysis.

Added by Alexey Badianov,
InstaForex specialist in finance