In each country whose currency is traded in the Forex market, the Central Bank of the respective country will determine the overnight lending rate the commercial banks. The control of interest rate is essential for the central bank of a country to implement its monetary policies. Hence, the interest rate is used as a tool to expand or contract the money supply. Generally, a lower interest rate will cause a country ’s currency to depreciate.
This is because of the Forex traders who indulge in carry trades. This is a trading strategy where a Forex trader sells a currency that is yielding low interest for another currency that is earning a higher interest rate. The currencies with higher interest rates will normally rise in value. In addition, with trading rollover, traders are also able to earn interest daily.
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