Interest Rate Differential
The difference in benchmark interest rates between two currencies, driving forward points, swap rates, and carry trades.
The interest rate differential is the gap between the benchmark rates set by two countries' central banks. In forex, this differential drives forward points, swap rates, and carry trade profitability. When one currency offers a significantly higher yield than another, capital flows toward the higher-yielding currency, influencing exchange rates over time.
How It Works
- Central banks set benchmark rates that determine borrowing costs in their currency
- The differential = rate of one currency minus the rate of the other
- Brokers charge or pay overnight swap rates based on the differential
- Forward exchange rates are mathematically derived from spot rate and the interest rate differential
Trading Tips
Carry trades work best when the differential is wide and the higher-yielding currency is trending up
Check your broker's actual swap rates, which may differ from the theoretical differential due to markup
Central bank meetings that narrow or widen differentials create the biggest shifts in carry trade dynamics
Related Terms
Put Your Knowledge Into Practice
Compare regulated brokers and find the best one for your trading style.
matched with AvaTrade
2 minutes ago