How does increase in interest rates lead to an increase in exchange rates?

Can someone explain it to me plainly? ALSO, I'm wondering if it works vice versa - does lowering interest rates lower the exchange rate?How does increase in interest rates lead to an increase in exchange rates?Hello,

Yes you are correct in what you are saying. I will use and example as it's easier to follow the reasoning. An increase in the interest rates is always good news for savers - if the IR is 2% and you put 10 into the bank you will earn 20p if the IR is 3% you earn 30p. Now think about this with larger amounts of money, you could earn alot more by putting your money into a bank where the IR is higher. Let's say you have US$ and the UK Bank of England increases its IR from 2% to 3%. When you move your money, you are increasing the supply of US$ in the market (ECO 101: increase in supply lowers the price), you are also wanting UK (increase in demand for increases the price) - put these two factors together and you will find that the gains strength. When a currency becomes stronger it means it is worth more of the other currency it is compared against. 1 = $ 1.5 --%26gt; 1 = $1.6

The increase in the IR will lead to the strengthening against the $ leading to it being worth more $. The opposite is also true.

Hope this helps.