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.
Upbeat economic data or figures that show consistent improvement across time periods reflect improving economic performance, which eventually translates to an interest rate hike or a tightening of monetary supply by the central bank. This is because good economic data means that the economy can survive even without additional stimulus from the central bank. By the Law of Supply and Demand, the lower amount of currency in circulation in the economy increases its value. At the same time, the hike in interest rates means that there's a higher return in holding the country's assets and currency, leading it to appreciate.
On the other hand, weak economy data reflects poor economic performance. This can push the central bank to cut interest rates or increase the amount of cash circulating in the economy. In turn, the increased supply of the currency in circulation lowers its value while the cut in interest rates results in lower returns in holding the currency. When combined, these factors result to a decrease in demand for the currency, thereby decreasing its value.
This explains why traders usually monitor monetary policy statements and central bank interest rate announcements. Other than showing if the central bank decided to change interest rates or asset purchases, central bank officials' assessment and predictions for the economy are also typically included. In fact, some central bank governors hold press conferences right after the actual announcement in order to shed more light on their monetary policy plans. They can even talk about the factors, such as employment or inflation, that can influence their decision to change interest rates or money supply.
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.
Upbeat economic data or figures that show consistent improvement across time periods reflect improving economic performance, which eventually translates to an interest rate hike or a tightening of monetary supply by the central bank. This is because good economic data means that the economy can survive even without additional stimulus from the central bank. By the Law of Supply and Demand, the lower amount of currency in circulation in the economy increases its value. At the same time, the hike in interest rates means that there's a higher return in holding the country's assets and currency, leading it to appreciate.
On the other hand, weak economy data reflects poor economic performance. This can push the central bank to cut interest rates or increase the amount of cash circulating in the economy. In turn, the increased supply of the currency in circulation lowers its value while the cut in interest rates results in lower returns in holding the currency. When combined, these factors result to a decrease in demand for the currency, thereby decreasing its value.
This explains why traders usually monitor monetary policy statements and central bank interest rate announcements. Other than showing if the central bank decided to change interest rates or asset purchases, central bank officials' assessment and predictions for the economy are also typically included. In fact, some central bank governors hold press conferences right after the actual announcement in order to shed more light on their monetary policy plans. They can even talk about the factors, such as employment or inflation, that can influence their decision to change interest rates or money supply.
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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