The rapid rise in inflation is one of the significant issues of the last two years for businesses and societies worldwide. It is also a critical measure of analysis for the trading decisions of investors and traders. To tame the rapid rise in inflation, central banks pursued a policy of aggressive interest rate hikes.

Short-term real interest rates

The rise in interest rates saw short-term interest rates move positively for all developed countries, including the US, UK, Switzerland, and Eurozone countries. Short-term interest rates, formally known as the "money market rate" and the "T-bill rate", are the rates at which short-term borrowing is done between financial institutions or the rate at which short-term government securities are issued or traded in the market.

Despite their rise and the positive returns, they offer, given the continued persistence of high inflation, as seen in the charts below, Real Short-Term Interest Rates are consistently negative for most major European economies but not for the US.

fxsoriginal

Real interest rates refer to interest rates adjusted for inflation representing the real return on investment. So, the real interest rate in Austria in May was -5.63% in Italy, it was -4.28% in the UK -3.7% in Germany -2.74% in France -1.75% and in Switzerland -1.12%. Meanwhile, in the US, real interest rates were positive as they stood at +1.10% in May.

It is crucial for forex traders to be aware that short-term real interest rates can have a significant impact on the foreign exchange (FX) markets.

The impact on the FX market

Higher short-term real interest rates, such as higher real US interest rates, tend to make the dollar more attractive to investors. When a country's interest rates are higher than other countries, it creates a higher return on investment for investors holding that currency. As a result, there is increased demand for the currency, leading to an appreciation of its value relative to other currencies.

In fact, when short-term real interest rates rise, this encourages capital inflows from foreign investors seeking higher returns. These investors can convert their funds into the currency at higher interest rates, increasing demand for that currency and potentially causing it to appreciate. Conversely, when short-term real interest rates fall, it can lead to capital outflows as investors seek better opportunities elsewhere, potentially weakening the currency.

In addition, short-term real interest rates can affect carry trade strategies. Carry trade involves borrowing in a currency with low-interest rates and investing in a currency with higher interest rates. Higher short-term real interest rates make the carry trade more attractive as the interest rate differential and potential profit increase. This increased demand for the higher-yielding currency can lead to its appreciation.

Higher real interest rates can also be seen as a measure to control inflation, thus can boost confidence in the currency's stability and attracting foreign investors by strengthening the currency.

Target of central banks

Central banks closely monitor the course of short-term real interest rates. As it determines their actions and policies, including interest rate decisions, significantly impacting foreign exchange markets. The FED succeeded in curbing inflation and driving real interest rates into positive territory. It remains to be seen whether the UK and Eurozone central banks will succeed in achieving the same goal so as to avoid any pressure on their currencies that may come from the realm of negative real interest rates.

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money. The Article/Information available on this website is for informational purposes only, you should not construe any such information or other material as investment advice or any other research recommendation. Nothing contained on this Article/ Information in this website constitutes a solicitation, recommendation, endorsement, or offer by LegacyFX and A.N. ALLNEW INVESTMENTS LIMITED in Cyprus or any affiliate Company, XE PRIME VENTURES LTD in Cayman Islands, AN All New Investments BY LLC in Belarus and AN All New Investments (VA) Ltd in Vanuatu to buy or sell any securities or other financial instruments in this or in in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction. LegacyFX and A.N. ALLNEW INVESTMENTS LIMITED in Cyprus or any affiliate Company, XE PRIME VENTURES LTD in Cayman Islands, AN All New Investments BY LLC in Belarus and AN All New Investments (VA) Ltd in Vanuatu are not liable for any possible claim for damages arising from any decision you make based on information or other Content made available to you through the website, but investors themselves assume the sole responsibility of evaluating the merits and risks associated with the use of any information or other Article/ Information on the website before making any decisions based on such information or other Article.

Recommended Content


Recommended Content

Editors’ Picks

EUR/USD climbs above 1.0400 on broad USD weakness

EUR/USD climbs above 1.0400 on broad USD weakness

EUR/USD gathers bullish momentum and trades above 1.0400 on Monday. The US Dollar remains under heavy selling pressure and helps the pair push higher as risk mood improves on news of US President-elect Donald Trump considering tariffs that would only cover critical imports.

EUR/USD News
GBP/USD surges above 1.2500 as risk flows dominate

GBP/USD surges above 1.2500 as risk flows dominate

GBP/USD extends its recovery from the multi-month low it set in the previous week and trades above 1.2500. The improving risk mood on easing concerns over Trump tariffs fuelling inflation makes it difficult for the US Dollar (USD) to find demand and allows the pair to stretch higher.

GBP/USD News
Gold retreats from session highs, holds above $2,620

Gold retreats from session highs, holds above $2,620

Gold struggles to keep its footing and retreats from the session high it set near $2,650. Following a decline in the European session, the benchmark 10-year US Treasury bond yield recovers to the 4.6% area, capping XAU/USD's upside in the second half of the day.

Gold News
Bitcoin Price Forecast: Reclaims the $99K mark

Bitcoin Price Forecast: Reclaims the $99K mark

Bitcoin (BTC) trades in green at around $99,200 on Monday after recovering almost 5% in the previous week. A 10xResearch report suggests BTC could approach its all-time high (ATH) of $108,353 ahead of Trump’s inauguration.

Read more
Five fundamentals for the week: Nonfarm Payrolls to keep traders on edge in first full week of 2025

Five fundamentals for the week: Nonfarm Payrolls to keep traders on edge in first full week of 2025 Premium

Did the US economy enjoy a strong finish to 2024? That is the question in the first full week of trading in 2025. The all-important NFP stand out, but a look at the Federal Reserve and the Chinese economy is also of interest. 

Read more
Best Forex Brokers with Low Spreads

Best Forex Brokers with Low Spreads

VERIFIED Low spreads are crucial for reducing trading costs. Explore top Forex brokers offering competitive spreads and high leverage. Compare options for EUR/USD, GBP/USD, USD/JPY, and Gold.

Read More

Majors

Cryptocurrencies

Signatures