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What is the impact of a stable economy on the forex market? Right now the European economy is very unstable with the economic crisis, and in the last days we have been watching a decrease in the value of the EUR, but with Interest rates going up (or with the possibility of them going up) shouldnâ€™t we see an increase in the value of the EUR?
admin answers: The core of the relationship between interest rate and Currency exchange rate is Demand and Supply. Interest rate affects the returns of the bond, for example, the US bond denoted in US dollar, you need to buy US dollar in order to buy their bond. High interest rate create a demand for US bonds. A low interest rate relative to other major economy will do the opposite way, reduce the demand for dollar. It is true under normal economic condition.
However under a recession. Relationship becomes abit inverted. Investors tend to put money into safer assets, even if the interest rate is lower. In late summer 2008, for example, the U.S. Dollar gained value against the euro even as interest rates in the U.S. Were significantly lower because the likelihood of a U.S. Default on Treasuries was deemed less than in Europe. Therefore, the Euro might have a higher interest rate, but as long as the investors doesn’t buy into the idea that Euro is ‘safe’, they are more gladly to park their money in US, or other emerging economies.
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