The Role of Monetary Policy in Forex Trading
Forex traders that use fundamental analysis for making trade decisions, especially in determining swing trade ideas, monetary policy decisions and central bank statements provide good clues in forecasting price behavior of currencies. After all, it is the central bank officials that decide on the level of interest rates and money supply. In turn, these determine the rate of return on the country's currency and the supply of cash circulating in the economy. This is also why forex traders often keep close tabs on economic releases, as these help them predict if a currency is about to rally or drop.
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 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.
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 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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Monetary policy statements and central bank decisions play a major role in determining if a currency is about to appreciate or depreciate. Learn more about how these events affect forex trading read more here.
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