How Interest Rates Affect Currencies

If an investor can lend money to one of the following; a German willing to pay 0.5% per year in interest, an American willing to pay 1% per year in interest. The choice is simple – to receive the most interest, they’d choose the American. To do that, they’d first have to buy US dollars in order to lend them to the American. If several investors do that, it’ll drive up the value of the dollar. Money is like anything else in that when there is too much supply, its price goes down (and its price is reflected by its interest rate). If all the money flooding into America causes interest rates to fall, the picture could look like this; a German willing to pay 0.5% per year in interest, an American willing to pay 0.25% per year in interest. Investors, naturally, would want the American to pay them back (in reality, they’d sell that “bond” on to someone else), and sell those dollars and buy euros in order to lend to the German. Lower American interest rates effectively pushed down the value of the dollar, and vice versa for the euro, all else being equal (there are other things that affect the value of a currency, like inflation).