Interest rate differential

Interest rate differential refers to the difference between the interest rates offered by two different countries for similar financial assets or loans. It influences currency exchange rates because investors often seek higher returns, which can lead to currency appreciation in the country with higher interest rates. Conversely, if a country has lower rates, its currency may weaken as investors move their money elsewhere for better yields. This concept helps explain movements in exchange rates and investment decisions across borders, reflecting the relative attractiveness of different national markets based on their interest environments.