Discount rates when trading forex

Despite the fact that there is always a heated discussion around news trading about the effectiveness or ineffectiveness of this method, nevertheless, based on important key statistics, the majority of traders, as a rule, agree on the impact on the movement of quotes.
Yes, you as a trader can completely refuse trading on news, however, not paying attention to the publication of important strategic economic data is simply tantamount to suicide of your deposit.

It has also long been a proven fact that there are almost 100 percent news that have a huge impact on the Forex market, and discount rates are among them.

Discount rate. Impact on exchange rates

The discount rate, or most likely its change, is the most important tool in the hands of the head of the national bank, with the help of which the value of money is directly influenced. The concept of the discount rate is actually quite simple: it represents the initial interest rate at which each country's central bank lends funds to domestic banks. Thus, the central bank directly influences the price of money, as raising the discount rate increases the amount domestic banks repay the central bank.

Also, continuing this chain, it's worth noting that banks, in order to recoup borrowed funds, increase their interest rates, which ultimately leads to an increase in the cost of credit for the average person.

A reduction in the interest rate, on the contrary, reduces the cost of the money supply, so the cost of credit for an ordinary person is an order of magnitude less, since the intermediary bank will have to pay a smaller amount to the central bank.

After reading the paragraph above, you've likely formed the impression that a low interest rate is a good indicator of economic growth, while a high rate is a bad sign. However, this first impression is always misleading, as we need to continue the chain of events, not just stop at the average person receiving a bank loan.

The core of any economy is investment inflow. The key interest rate is one of the most important indicators for every investor. A low key interest rate leads to a low cost of money, and consequently, lower deposit interest rates.

Therefore, it makes no sense for a large investor to keep funds in the country and invest in the economy, since the very low interest rates on deposits are practically equal to inflation.

Higher interest rates raise the cost of money growth and simultaneously increase the interest banks charge on deposits. Typically, in countries with high interest rates, the interest paid on depositors' deposits is also high, resulting in an economy that is always oversaturated with money.

Therefore, when trading in the forex market, a rise in interest rates is always seen as a positive phenomenon that leads to a rise in currencies, while a fall in interest rates is seen as a negative phenomenon that leads to a fall in currencies.

Peculiarities of using data on the key interest rate in Forex

If you closely study the impact of the key interest rate over the historical period of different currency pairs, you'll notice that the market reaction in certain situations varies dramatically. This is because speeches by national bank governors or members of monetary policy bodies create certain beliefs among investors.

For example, the heads of the US Federal Reserve regularly give speeches indirectly touching on interest rate data and potential rate moves. Consequently, the forex market, having received specific signals about interest rate moves, often begins to react to the situation a month before the actual release, and then practically nothing happens when the interest rate data is released.

The market is also highly volatile if the key rate changes contrary to expectations or signals sent by the regulator. In such cases, fluctuations are very strong and even lead to a reversal of the market trend.

Why do some currencies not respond to changes in the key rate?

Typically, the lack of reaction from the forex market occurs in currency pairs in countries with very high interest rates and high inflation, and the change in the key interest rate is insignificant. For example, if interest rate in Russia is 10 percent, then its increase or decrease by 0.5 percent will not bring about practically any changes.

Think about it: you wouldn't take out a mortgage at 10 percent or 10.5 percent, because the interest rate is still too high in both cases. In countries with extremely low inflation, changes of just a fraction of a percent will have a huge impact on the market.

In conclusion, I would like to note that the key rate is one of the most important tools in the hands of the regulator, therefore its change is almost always reflected in the exchange rate of the national currency.