It is vital to comprehend what causes the movements of currency pairs if you are willing to make money in forex. At the end of the day, investors are the ones who move currency pairs by buying and selling various currencies, but something makes them do it. Either the investors observe something fundamental taking place in the global economy that indicates an economy strengthening or weakening. To put it simply, they monitor the fundamentals for making their decisions.
Currency pairs are moved by fundamentals. If the economic fundamentals in the US improve, the USD gets stronger because forex investors buy dollars. On the contrary, if the fundamentals in the US decline, the USD gets weaker because investors sell it.
You can learn monitoring the fundamental indicators moving the currency pairs the way institutional investors do. To learn it, you need to know about the most important fundamental economic indicators.
Not All The Economic Indicators Are to Consider
People around the world are brought closer due to globalisation and it also makes millions of pieces of information always available at our fingertips. If you want to become a successful forex investor, you need to learn how to focus only on the important information and ignore the useless information.
Keep in mind that not all economic indicators are important. There are many fundamental economic announcements that you do not need to pay attention to. For example, unemployment in Ireland may be important in Ireland, but it is not as internationally important as unemployment in the US. The US economy has a great impact on the global economy. So, as an investor, you must pay close attention to the US economic announcements.
Ultimately, you have to monitor the same things that institutional investors that move the forex market are watching. By doing it, you can predict the moves of these investors accurately and you can also benefit from those movements.
How Interest Rates Impact Money Supply
One thing you must know is that the forex market is ruled by interest rates. Currencies that represent economies with higher interest rates are stronger than currencies that represent economies with lower interest rates. Investors always look for the best return on investments, and that is usually provided by economies with higher interest rates.
Assume that you are comparing two banks to put your money. Let us say that bank A is offering to pay 6% interest for your money. The other bank, bank B is offering only 2% interest on your money. Obviously, you need to choose bank A because with 6% interest rate, there will be a better return on investment.
The same principle is applied when it comes to economies and their respective currencies. If you are getting a 6% return on investment in the UK but only get a 2% return on investment in Switzerland, it is smart to invest in the UK. However, you need to know how this will affect the value of the GBP (British Pound). As more people invest their money in the UK, the demand for GBP is increased. From basic economies, we know that when demand increases, the value of the currency, GBP in this case, increases as well.
Successful forex investors never stop monitoring the organisations that set interest rates, for example, central banks. It is important to monitor closely to note in the banks are likely to raise or lower interest rates or keep them unchanged in the future.
The most important central banks are –
- Federal Reserve (The Fed) – United States
- European Central Bank (ECB) – European Union
- Bank of England (BOE) – United Kingdom
- Bank of Japan (BOJ) – Japan
- Swiss National Bank (SNB) – Switzerland
- Bank of Canada (BOC) – Canada
- Reserve Bank of Australia (RBA) – Australia
- Reserve Bank of New Zealand (RBNZ) – New Zealand
How Inflation Impacts Currency Value
Apart from monitoring central banks, successful forex investors also monitor the economic numbers monitored by central banks while making their decisions regarding interest rate. By doing this, they can determine what central banks may do more accurately.
Inflation is one of the most important economic indicators watched by central banks to make their interest-rate decisions. Inflation refers to the general price in prices for services and products. For example, you definitely pay more for goods now than you did a decade ago. You may also have heard from earlier generations commenting on how expensive things are at present. All of us face inflation. If the inflation is moderate, people usually accept it considering a natural by-product of economy growth. However, too much inflation can hurt an economy,
Central banks always look out for rising inflation. When inflation rises to uncomfortable levels, they do everything to stop that growth. One common thing they do to stop the growth is raising interest rates. Due to higher interest rates, it becomes difficult for individuals and businesses to borrow money for buying and producing new items. So, economic growth, as well as inflation, is slowed down as a result.
Forex investors need to monitor inflation rates to understand what central banks are going to do with their interest rates. If inflation rises, central banks will most probably raise interest rates as well, because it will be the right thing to do for the representative currency of the economy. There are the two economic inflation indicators you need to observe to get an idea of what central banks are paying attention to –
CPI – Consumer Price Index:
This economic indicator is used to measure the cost of the goods bought by the consumers regularly. The more money the consumers pay on essential goods and services, the less money they need to spend on extra goods and services.
PPI – Producer’s Price Index:
This economic indicator is used to measure the amount producers require to purchase raw materials that are used to produce the goods. If the price of production rises, producers pass the costs onto customers.
Once you understand the importance of interest rates and the impact of inflation on interest rates, you can make decisions on your investments more accurately.