Forex News & Currency Analysis

Tomorrow at 1:30pm GMT the Forex world will suddenly turn silent, as the US Bureau of Labor Statistics announces the Change in Non-Farm payrolls for January. Whether or not the change in this critical report is better or worse than expected, the forex market will immediately enter into a sea of volatility.

The fact that this one report has such a strong impact on the market, leaves us asking what does this report even mean? In Short, the Non-Farm payroll is defined as the change in the number of employed people during the previous month, excluding the farming industry. It represents the total number of paid U.S. workers of any business, excluding general government employees, private household employees, employees of nonprofit organizations that provide assistance to individuals, and farm employees.

For the first time in a long time, analysts are expecting an increase in the Non-Farm payrolls of 10K- meaning that they are predicting that 10,000 more people will have been employed this January, than in December (of 2009). For such a small number, what is all the hype about? While this number appears small, it is a tremendous step for the U.S economy. For all of 2009, the Change Non-Farm Payroll was continuously negative- the fact that for the first time in over a year, the report is finally predicted to show an increase in employment, thus further supporting claims that the U.S will finally exit the recession.

Tomorrow’s release of the NFP, followed by the US unemployment concludes one of the busiest weeks in the forex world. Investors are advised to closely watch this report. A lower than expected increase in the NFP, will surely cause the dollar weaken against its major counterparts, wiping out some, if not all, of this week’s gains. While, a better than expected change in the report, will not only send the USD spiraling upwards, but it will final confirm that the U. S is in fact on the path to financial recovery.

Today, Bank of England as well as European Central Bank will announce their highly anticipated benchmark rate decision. While, both central banks are expected to leave their overnight rates unchanged, at their historically low levels of 0.5% and 1.0%, respectively; a deviation from these predictions would send the forex market into a whirlwind of volatility.

The fact that a change in interest rates could have such a beneficial or detrimental effect on a country’s currency price, begs us to ask the question, why are interests rates so important?

Interest rates, set by the central banks, play a vital role in the movement of currency prices in the forex market. As currencies are a depiction of country’s economy, differences in interest rates affect the comparable worth of currencies in relation to one another. Thus, when central banks decide to raise or lower their country’s interest rates, they can send the Forex Market into frenzy.

In the world of Forex Trading, an accurate prediction of the direction the central bank will take when it comes to changing the interest rate can significantly increase a trader’s chances of success.

But how do interest rates affect the currency market? Basic economics dictates that if demand rises and supply remains constant, then as a result, prices will increase. This exact principal can be applied to the Forex market when interest rates are increased. When the central bank raises its country’s interest rate, it encourages investors to invest in the country- thus increasing demand for the currency.  A higher interest rate allows investors to receive a higher yield on their investment, thus investors are drawn to the currency. As demand rises causing more investors buy the currency, the available supply on the market shrinks; consequentially causing the currency to become more valuable.  In contrast, a fall in the interest rate, would cause the economy’s currency will depreciate as a result of the weaker demand.

When the financial crisis hit last year, the immediate reaction of developed countries central banks, was to lower their benchmark rate. The decision behind lower the interest rates was based upon one of the founding principles of how monetary policy works.

When a central bank lowers its official rate, it is in effect attempting to influence the overall level of expenditure in the economy. Basically, a reduction of interest rates makes saving less attractive and borrowing much more appealing.

Lower interest rates affect consumers’ as well as firms’ cash-flow,  as a fall in interest rates reduces the income from savings as well  the interest payments due on loans. As a result, borrowers tend to spend more of any extra money they have than lenders, so the net effect of lower interest rates through this cash-flow channel is to encourage higher spending in aggregate. Which is exactly what the central banks hoped would occur when they drastically lowered their countries interest rates.

This brings us to today’s rate decision for the EU and UK. With unemployment still high, and recovery from the recession still wavering, it is predicted that that both Central Banks will keep interest rates at their current historically low levels – hopefully giving both economy’s a stronger and final push towards economic recovery.