Why do higher interest rates cause the exchange rate of a currency to rise?

Interest rate's determine the monetary benefit of saving an individuals disposable income - i.e. the rate of return on their savings deposits. When interest rates are higher, individuals stand to gain more from saving, so they tend save more. Through this logic, higher interest rates also entice foreign investment in domestic accounts - in order for foreign investors to place their money into domestic accounts they need to exchange their money into the domestic currency. This creates a demand for the domestic currency - for example the pound - which in turn increases the relative value of this currency to other currencies, also called the exchange rate.

Answered by Jamie P. Economics tutor

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