Real Interest Rate: How It Affects the Economy and Forex Market

9 de nov. de 2023

Real interest rate is the interest rate adjusted for inflation. Nominal interest rate is the reported rate, while real interest rate is the actual rate that the borrower receives after accounting for inflation.
The formula for calculating real interest rate is as follows:

Real interest rate = Nominal interest rate - Inflation rate

For example, if the nominal interest rate is 5% and the inflation rate is 3%, then the real interest rate is 2%.
Real interest rate plays an important role in the economy. High real interest rates can encourage investment and economic growth. Conversely, low real interest rates can dampen investment and economic growth.

Real interest rate has a significant impact on the forex market. An increase in the real interest rate will make the domestic currency more attractive to foreign investors. This is because foreign investors can earn higher returns from their investments in countries with high real interest rates. An increase in the real interest rate will cause the domestic currency to appreciate against foreign currencies. This is because foreign investors will increase demand for the domestic currency to invest. A decrease in the real interest rate will cause the domestic currency to depreciate against foreign currencies. This is because foreign investors will reduce demand for the domestic currency to invest.

Here are some examples of the impact of real interest rates on the forex market:
In 2022, the US Federal Reserve (The Fed) raised the real interest rate. This caused the US dollar to appreciate against other currencies.
DXY

USDJPY

USDDKK

USDCNH

In 2022, the European Central Bank (ECB) lowered the real interest rate. This caused the euro to depreciate against other currencies.
EURCAD

EURCHF

EURSEK

Governments and central banks can use the real interest rate as one of the instruments of monetary policy to influence the exchange rate of the currency. For example, if the government wants to increase the exchange rate of the domestic currency, the government can raise the real interest rate. Real interest rate can be used to predict the movements of currency pairs. Currency pairs with higher real interest rates tend to appreciate against currency pairs with lower real interest rates.

Here are the steps for using real interest rate to predict the movements of currency pairs:

1. Collect data on real interest rates from the two countries whose currencies form the currency pair.
   
2. Compare the real interest rates of the two countries.
   
3. If the real interest rate of country A is higher than the real interest rate of country B, then the currency pair A/B will tend to appreciate.
   

For example, the real interest rate of the United States is 1.8%, while the real interest rate of Japan is -3.1%. Therefore, the currency pair US dollar/Japanese yen (USD/JPY) will tend to appreciate by 4.9%.


Real interest rate is only one factor that affects the movements of currency pairs. Other factors that should also be considered include economic and political factors that can affect the demand and supply of the two currencies.