Economic Growth and Forex Interest Rates

How crucial is a country's economy in the changes in interest rates? Do we need to watch a country's economic health before we invest in its currency? How true is it that some currencies are immune from the ups and downs of their country's economy?

When predicting the trends of a country's currency we have to take into account developments in the country's economic activities. The rule is that when an economy is strong its central bank is bound to increase its interest rates to contain inflation. When interest rates are up more currency foreign investments are likely to pour into the country making its economy more stable.

When more foreign investments come in it makes the currency of the host country more in demand globally and this makes the currency value higher. But when there is an unfavorable event affecting the economy of a country it can produce a reverberating adverse effect starting from interest rates, foreign investments, demand for the currency, and currency value.

For instance, from the year 2005 to 2006, the Euro and the US dollars (EUR/USD) had remarkable currency movements. In said period the Euro economy performed dismally compared to the outstanding performance of the US economy which had a 3 percent growth, while the Euro only had a 1.5 percent growth. The growth rate difference also triggered a difference in interest rates.

The EUR/USD currency comparison dropped almost 2000 basis points in 2005. But the following year the European economy started to perform better and the US growth rate started slowing down. By year's end the EUR gained as its economy strengthened and its interest rates also increased. Thus, as a country's gross domestic product (GDP) increases or decreases so do its interest rates. And it would be easy to forecast interest rate trends when we closely observe its country's GDP.

In mid-2006, because of the real estate debacle, the US economy started to go down. There was talk about lowered interest rates that went around in the first part of 2007 and that triggered the withdrawal of many foreign investments. As this development happened, the Japanese economy was being improved by its exports triggered by low prices. If we had invested in the USD/JPY pair in favor of the yen we would have made a big profit because the US economy took a further beating.

Thus, we see that economic stability has lots to do with interest rates. We have to watch both to make a good profit in forex trading.