How do higher interest rates affect exchange rates?

Higher interest rates attract foreign capital and cause the exchange rate to rise. The impact of higher interest rates is mitigated, however, if inflation in the country is much higher than in others, or if additional factors drive the currency down. The opposite relationship exists for decreasing interest rates.

How do interest rates affect currency value?

A country’s currency will rise in value when interest rates are high because higher rates will attract more foreign capital. This will lead to an increase in exchange rates and a strong currency. As a general rule, the higher the interest rates, the more foreign investment a country is likely to attract.

Why do exchange rates rise?

This increase in demand will cause the value to rise. Therefore movements in the exchange rate do not always reflect economic fundamentals but are often driven by the sentiments of the financial markets. For example, if markets see news which makes an interest rate increase more likely, the value of the pound will probably rise in anticipation.