Interest Rate Differential

The interest rate differential is the gap between the benchmark interest rates of the two economies behind a currency pair. When one central bank pays materially more than the other, capital tends to flow toward the higher-yielding currency, and the same gap determines the swap or rollover a trader pays or earns for holding a position overnight. Rate differentials, also called yield spreads, are a core fundamental driver in forex: they underpin the carry trade and much of the medium-term trend in major pairs. What usually moves price is not the current gap but the expected change in it, so traders follow policy statements, inflation prints and rate futures to judge where the differential is heading.