For forex traders that pay attention to fundamentals, particularly in coming up with longer-term trade setups, monetary policy statements and central bank interest rate decisions are huge factors in predicting future price action. This is because central banks ultimately determine interest rates, which dictate the return on the country's assets and its currency, and the level of liquidity in the markets. This is the core reason behind the idea of watching economic reports in order to figure out whether a currency is set to appreciate or depreciate.
Strong economic data reflects good economic performance, which can lead the central bank to hike interest rates or reduce the amount of cash circulating in the economy. In doing so, the lower supply of the currency in circulation boosts its value while the increase in interest rates translates to higher returns in holding the currency. All in all, these factors translate to an increase in demand for the currency, therefore increasing its value.
On the other side of the coin, poor economic figures mean that the economy isn't doing so well. This can lead the central bank to slash interest rates by a few basis points or flood the economy with extra cash. The increased money supply in the economy translates to a reduction in value of the currency, as dictated by the Law of Supply and Demand. The drop in interest rates reflects lower return on holding the currency, so there's weaker demand for the currency, leading it to depreciate.
This is why forex traders pay close attention to monetary policy announcements and actual central bank rate decisions. Aside from containing the decision on money supply and interest rates, policymakers also include their assessment and outlook for the economy. Central bank announcements are typically followed by a press conference, wherein the central bank governor usually talks about future monetary policy plans. As an example, some central bank heads can specify that their future monetary policy decision is hinged on the outcome of labor reports or inflation figures.
In addition, testimonies and media interviews of policymakers also influence forex price action as their remarks could be treated as clues for upcoming monetary policy decisions. A central banker can drop some comments saying that more asset purchases are necessary and this can lead to a strong selloff in the corresponding currency, as traders use these clues to price in their speculations for actual policy decisions. This explains why central bank speeches are typically included in forex economic calendar events.
Strong economic data reflects good economic performance, which can lead the central bank to hike interest rates or reduce the amount of cash circulating in the economy. In doing so, the lower supply of the currency in circulation boosts its value while the increase in interest rates translates to higher returns in holding the currency. All in all, these factors translate to an increase in demand for the currency, therefore increasing its value.
On the other side of the coin, poor economic figures mean that the economy isn't doing so well. This can lead the central bank to slash interest rates by a few basis points or flood the economy with extra cash. The increased money supply in the economy translates to a reduction in value of the currency, as dictated by the Law of Supply and Demand. The drop in interest rates reflects lower return on holding the currency, so there's weaker demand for the currency, leading it to depreciate.
This is why forex traders pay close attention to monetary policy announcements and actual central bank rate decisions. Aside from containing the decision on money supply and interest rates, policymakers also include their assessment and outlook for the economy. Central bank announcements are typically followed by a press conference, wherein the central bank governor usually talks about future monetary policy plans. As an example, some central bank heads can specify that their future monetary policy decision is hinged on the outcome of labor reports or inflation figures.
In addition, testimonies and media interviews of policymakers also influence forex price action as their remarks could be treated as clues for upcoming monetary policy decisions. A central banker can drop some comments saying that more asset purchases are necessary and this can lead to a strong selloff in the corresponding currency, as traders use these clues to price in their speculations for actual policy decisions. This explains why central bank speeches are typically included in forex economic calendar events.
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How exactly does monetary policy drive price action in the forex market? Read this article to learn about the role of interest rate decisions in trading additional info.
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