The Forex market has a very strong correlation with the Central Bank and the decisions issued by the Governor of the Central Bank and also the interest rate issued by the Central Bank greatly affect the country’s currency and its price in the Forex market.
A Complete Guide to Central Banks and Their Role in the Forex
1 – Understanding Central Banks
The central bank is the bank that controls all banks in the country. It is the bank that issues important decisions and laws such as monetary policy, interest rates, and inflation rates. It can also determine the percentage of cash reserves for each bank in the country.
The Central Bank is One of the most important factors affecting Forex that you should follow as a Forex trader because the decisions issued by the Central Bank have a very significant impact on the movement of the markets, and these decisions determine the fate of the country’s currency, whether it will rise in the long term or fall.
Also, the decisions of the Central Bank may be in the long term or the short term. There are very sensitive decisions that greatly affect the currency and its future in the market, and there are decisions that the market may react to temporarily, and then things become normal after that.
Examples of major central banks
Each country has its own central bank to control the rest of the banks, as we mentioned previously. For example, these are the central banks of the largest countries in the world.
Federal Reserve
The Federal Reserve is the central bank of the United States and is considered one of the strongest central banks in the world. Many traders await its decisions in order to make appropriate trading decisions.
European Central Bank
The European Central Bank is responsible for all European banks.
Bank of Japan
Also, the Japanese central bank and the same thing applies to it
2 – Monetary Policy and Forex Markets
Each country has its own monetary policy, and through this monetary policy, the country can grow economically and provide better livelihoods for citizens. The central bank is the one that is keen to present a monetary policy that suits the country and its economy. Among the tools of this monetary policy are:
Interest Rates
You may have heard the term interest rate before, but what is it?
Interest rates are the returns that the bank gives you in return for your deposits or for investment certificates or deposits that the bank offers. The Central Bank of the country supervises these interest rates and all banks are committed to implementing these decisions.
The Central Bank changes interest rates from time to time, either lowering it or increasing it, of course, depending on the country’s economic situation. Such important decisions are taken, It is also possible to not change the interest rates if these rates are satisfactory to the Central Bank, so there is no need to change them.
Interest rates are one of the most important news for traders, so you will notice that when the central bank’s interest rate decision date approaches, you will see that traders are very interested in this timing and are trading at this time in order to take advantage of the crazy movements that occur.
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For example, the US interest rate (Federal Bank) Because the United States is the largest country in the world economically and the dollar is linked to many currencies in Forex, it is natural that when the dollar is affected by any news (especially Interest rate) most currencies in Forex will be affected too.
The last interest rate decision issued on July 31 was to keep interest rates unchanged, You can follow interest rates through the economic calendar in Forex Factory from here.
Interest rates are usually issued every two or three months, depending on the monetary policy followed by the Central Bank. The interest rate date is also determined through the meetings held by the Central Bank.
How to read the interest rate News
To read interest rates, there are 3 columns on the right. The first column on the right is the last result that occurred. In this image, it shows that Interest rates appear to have remained unchanged. The column next to it is what analysts expect: will interest rates be kept unchanged, increased, or decreased? In this case, the expected result was that interest rates would be unchanged. The last column is the actual results of the event, which was expected by analysts, which was to stabilize interest rates.
interest rate
Interest rate news is usually released in the middle or end of the month on Tuesday or Wednesday.
Reading economic data on interest rates is not difficult, but what is more important is understanding the country’s monetary policy because it is possible that even after knowing what the central bank will do, whether to reduce, increase, or not change the interest rates, it is not necessary for the same movement to occur as it did previously.
Because the monetary policy followed by the central bank is what determines the fate of the currency, and interest rates are an important part of monetary policy, of course, but they are one part of many parts that must be put together in order to clarify the monetary policy followed by the central bank.
How to trade with interest rate
As we mentioned earlier, predicting the currency movement based on interest rates alone is a bit difficult, but you can certainly make profits, but not in the long term, and you will not always make profits when interest rates are issued.
You must know the monetary policy of the US dollar in order to understand the consequences of unchanged interest rates and what results will occur in the event of a decrease or increase in interest rates. All of these scenarios have logical answers for political analysts because they are aware of all this news and did not analyze interest rates only. They combined each element of monetary policy that made them aware of the strength of the currency, whether it would rise or fall.
interest rate impact
In this example, at the time of the news release, it was July 31. The EUR/USD pair fell sharply and then rose again. Its movement ranged between 15 and 20 pips, but this is a small movement, of course, compared to the price movement at the time of the interest rate news.
It is difficult to analyze the price movement at this time because interest rates have not changed for more than a year, but this is not an indication that every time the central bank decides to not change the interest rates, there will be a small movement. Other factors related to monetary policy are what help build a clear picture of the price movements, whether it will rise or fall, and also integrate technical analysis or SMC with news analysis.
interest rate impact 2
In this example, the pair fell more than 30 pips at the time of the news release, but that was not all. This decline was followed by a further decline for more than two days, achieving 170 pips due to the news about interest rates.
This example shows the importance of interest rate decisions on the future price of the currency. Of course, this is a small example, as there is news that has an impact that lasts for years.
Inflation
Inflation is the increase in the prices of goods and services and the decrease in the value of the currency. For example, if you buy enough food for a month for $1,000 and there is inflation in the country in which you live, Then next year you will buy the same food that you buy every month for $2,000. This is inflation: the increase in the value of goods and services and the decrease in the value of the currency.
Inflation is not necessarily bad for the country. There are countries whose economy depends on inflation. For example, Japan is a manufacturing country, so it is in its interest for its currency to have inflation because it exports its own products, and this inflation helps it in its economic growth.
Inflation may be beneficial, but it must be controlled so that it does not get out of control. Excessive inflation may harm the country. There are many countries that suffer from inflation and cannot treat this matter.
Inflation is the number one enemy of central banks All central banks around the world are adjusting their monetary policy to maintain inflation rates appropriate for their economy so that they do not suffer like other countries with high inflation rates.
You will find the inflation news for the dollar in the economic calendar (CPI) Consumer price index
CPI USD
This factor is a measure of individuals’ purchases of goods and services. This indicates the extent to which individuals accept the country’s products. Accordingly, inflation is calculated based on this.
The Core CPI is a measure of goods and services, food and energy items are excluded because it is difficult to determine their direction because they are seasonal and volatile goods.
How to trade with CPI
You will find that the market moves strongly when the CPI news is released because this news is one of the news that determines the fate of the currency in the future and it is a very important part of the monetary policy of the Central Bank. If inflation rates are too high, the Central Bank will take decisions to reduce this inflation and it is possible to increase interest rates. The two pieces of news are closely linked to each other.
CPI
On June 12, the inflation news was released and it rose by more than 60 pips. The best way to enter a trade with the inflation news is to see the previous result and the expected result by analysts. If the result is less than the previous one, the EUR/USD will rise (because the news will become negative for the dollar).
Of course, this scenario does not necessarily happen. It is natural for it to fall or rise based on the monetary policy followed by the Central Bank, as we mentioned previously. Also, the Governor of the Central Bank explains the monetary policy he follows through a press conference held after the interest rate news. Sometimes a press conference is held to clarify some matters away from the interest rate news release dates.
Quantitative easing
Quantitative easing is a monetary policy carried out by the central bank to boost the economy by reducing interest rates or buying assets, companies, or bonds. The goal of this is to increase liquidity in the market, which will increase demand for assets and thus will enable it to reduce interest rates because the price of assets will increase and their return will decrease in the long term.
Each country has its own monetary policy and accordingly follows quantitative easing that differs from one country to another. If the economy is stable, asset purchases will be reduced and the country will move to invest its money in other things in order to improve its economy.
