Fundamental analysis involves analyzing both the direction and the factors that influence the market.
This type of analysis has emerged before technical analysis and has been the only method of forecasting the direction of the market for a long time.
The fundamental analysis is more difficult when applied compared to technical analysis. When analyzing certain market conditions, and their behaviour on the currency pairs, you must pay attention to different factors and their influence on the market.
The number of factors to study, when applying the fundamental analysis are:
- Financial factors
- Macroeconomic factors
- Political factors
- Nature cataclysms and catastrophes
Today I will talk about the financial factors, such as interest rates and inflation rate.
Fundamental analysis involves studying key financial factors
The financial factors are one of the most important parameters that have a deal of influence on the forex market.
There is an indirect correlation between the interest rate and the level of inflation in a country.
The interest rates for each country differ and fixed by the superior bodies, represented by the European Central Bank, the Federal Reserve System in the USA, the Bank of Japan, the Bank of England, the Swiss National Bank and other similar entities.
When a central bank reduces the interest rate, the loan interest is minimized as well, which means that loans become cheaper for the consumers.
Thus, the demand for a loan and the number of loans extended increase, resulting in the increase of money in circulation, and mass consumption.
At the same time, money supply at a lower price leads to depreciation of the national currency in comparison to other currencies.
I conclude that the reduction in a country’s interest rate affects its currency negatively.
On the contrary, high-interest rates enable the fall in the demand for money, resulting in a declination of the amount in circulation.
People prefer to deposit money with banks to benefit from the high-interest rates. I conclude that the increase in the interest rates affects the national currency of a country positively.
What is the correlation between the interest rate and the inflation rate to maintain a national currency and an economy stronger?
Let’s suppose that the inflation rate is higher than the interest rate in a certain country. This means that there is no point for depositing money in the banks, as the national currency depreciates faster than the interest earned.
In other words, it is more profitable for a person to spend this money buying goods or services.
This scenario is pernicious to the economy of a country. If the interest rate and the inflation rate are equal, the situation will develop similarly, but more slowly, as a one to one interest rate/inflation rate ratio will lead to the oversaturation of the economy with money and will affect the national currency negatively.
Moreover, the perfect scenario for the economy of a country is when the interest rate is a bit higher than the inflation rate.
** This article was prepared by Evan Tzivanakis **