Interest rates - a significant impact on the value of a currency

Despite the support from leaders of the two most influencing central banks, the US dollar is unable to appreciate against its main rivals. The euro against the dollar is still stuck between 1.4800 and 1.5100, against the Swiss franc between 1.0000 and 1.0300 and against sterling between 1.6250 and 1.6850.

The statements by the President of the Federal Reserve, Ben Bernanke, who in a rare comment last week on the US dollar's value acknowledged that the currency's slump was causing some prices to rise and the President of the European Central Bank, Jean-Claude Trichet, who said that a strong dollar benefits the entire international community were not able to stable the greenback.

The situation on the foreign exchange market is currently stagnant. On the one hand, some investors are optimistic about global economic prospects for 2010, arguing that the worst of the crisis is behind us.

On the other hand, some investors expect a very difficult year in 2010; the economic situation is very unstable. The market will focus in coming weeks on expectations of change in interest rates monetary policy of different central banks, and the end of various stimulus packages.

According to the OCED report on the economic outlook released recently, the Organisation for Cooperation and Economic Development expects the eurozone, the US, UK and Japan to maintain status quo on interest rates.

Regarding exit strategies, the organisation said that the implementation of exit strategies cannot be delayed, as keeping stimulus for too long, could be damaging to the economy.

Basically, the interest rates of a country have a direct impact on their national currency. A high rate of return of a currency makes this very attractive.

As the graph shows, when the Bank of England began its wave of declining interest rates from December 13, 2007 to March 12, 2009, lowering interest rates from 5.75 per cent to 0.50 per cent, the British pound fell from 2.0414 to 1.3993 against the US dollar, a drop of over 30 per cent in 15 months.

The market does not miss the opportunity to enjoy a change of policy interest rates and the market will act aggressively on the currency that gets favoured by expectations of rising interest rates.

Upcoming FX Key events

There is no key economic data this week. US Unemployment report next week is approaching.

FX Technical Key points

EUR/USD is bearish, target 1.4300, key reversal point 1.5150
USD/JPY is bearish, target 85, key reversal point 92.50
GBP/USD is bearish, target 1.5050, key reversal point 1.7000
USD/CHF is bullish, target 1.0650, key reversal point 1.0000
AUD/USD is neutral, watch 0.8850 and 0.9500
NZDUSD is neutral, watch 0.7300 and 0.7725

Mr Longchamp is head of trading at RTFX Ltd.

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