Commander in Pips: Hmmm, very simple. Let’s suppose that you have a choice where to invest your money. Say, what do you choose – invest for 1% annually or 3%? Pipruit: Of course 3%! Commander in Pips: That’s right. So interest rates are important, because they dictate the attractiveness of one or another currency, determine world capital flows. Investors among other factors look at interest rates inside some country and decide if they will invest here or not. Pipruit: I’m still not quite understanding… Commander in Pips: Well, when investors see that some country has significant interest rates with other factors remain equal (for instance, a AAA rating by S&P), they will invest with that country, since it offers higher yield on their investments. Yield of all other assets, say, bonds will depend on Central Bank interest rates. Later we will also discuss such issues as carry trade that can fully use this possibility. But to buy something, say in Australia – stocks, you need to purchase Australian dollars. Only after that can you invest in stocks, since they denominated in AUD. When a solid part of world investors decide to invest in Australia due to it’s low budget deficit and high interest rates they start to buy AUD. These purchases lead to solid appreciation of the Australian national currency. The same happens with any other currency, if other risks do not change. Pipruit: And what other risks are? Commander in Pips: For instance, some emerging country could have even higher rates – 8%. But at the same time it could have 3-4 times faster inflation and worse credit quality, say BBB+ compared to AAA. This will not lead to as high of capital flows, since higher rate compensates for the higher risks. That’s why I’ve said “other factors remain equal”.