What Does Forward Guidance Mean In Forex Trading?
The recent set of interest rate statements for the past week has brought a new term and possibly a game-changer for the forex trading scene. Forward guidance is all about the disclosure of interest rate forecasts and monetary policy plans of the central bank, usually announced during monetary policy decisions.
In this week's Bank of England monetary policy statement, new BOE Governor Mark Carney stated that the markets shouldn't expect an interest rate hike until the middle of 2015. Meanwhile, European Central Bank Chairman Mario Draghi said that interest rates in the euro zone will remain low for an extended period.
The US Federal Reserve has been practicing this kind of communication strategy for quite some time already. Recall that Fed Chairman Bernanke has been saying that interest rates will kept at their record lows for an extended period time back when the US economy needed stimulus to recover from the recession. Recently, Bernanke continues to communicate the central bank's plans to the markets by saying that the open-ended asset purchase program will be tapered by the end of the year and possibly ended by the middle of next year.
For central bank officials, they are able to accomplish two objectives with forward guidance. First, they are able to keep a lid on bond market volatility by preventing interest rate expectations from causing sudden spikes in bond yields. In effect, they induce stability in borrowing costs, as these will no longer be driven by differing speculations but by actual forecasts from the central bank. Second, they are able to make the most of their current monetary policies by extending the effect of their rate cuts or asset purchases. Remember that several central banks already have record low interest rates and are running out of ideas when it comes to implementing more stimulus. By announcing that rates are likely to stay low for a number of years, they are able to influence lenders into keeping interest rates lower for longer-term loans without needing to slash rates lower or print more money.
With that, forex traders have a clearer idea of which central banks are dovish and which ones are less dovish. In the recent events, BOE and ECB have emerged to be the most dovish among the major central banks while the Fed is leaning towards tighter monetary policy. In effect, GBP/USD and EUR/USD could be in for longer-term trends in the coming months if the central banks retain their biases.
In this week's Bank of England monetary policy statement, new BOE Governor Mark Carney stated that the markets shouldn't expect an interest rate hike until the middle of 2015. Meanwhile, European Central Bank Chairman Mario Draghi said that interest rates in the euro zone will remain low for an extended period.
The US Federal Reserve has been practicing this kind of communication strategy for quite some time already. Recall that Fed Chairman Bernanke has been saying that interest rates will kept at their record lows for an extended period time back when the US economy needed stimulus to recover from the recession. Recently, Bernanke continues to communicate the central bank's plans to the markets by saying that the open-ended asset purchase program will be tapered by the end of the year and possibly ended by the middle of next year.
For central bank officials, they are able to accomplish two objectives with forward guidance. First, they are able to keep a lid on bond market volatility by preventing interest rate expectations from causing sudden spikes in bond yields. In effect, they induce stability in borrowing costs, as these will no longer be driven by differing speculations but by actual forecasts from the central bank. Second, they are able to make the most of their current monetary policies by extending the effect of their rate cuts or asset purchases. Remember that several central banks already have record low interest rates and are running out of ideas when it comes to implementing more stimulus. By announcing that rates are likely to stay low for a number of years, they are able to influence lenders into keeping interest rates lower for longer-term loans without needing to slash rates lower or print more money.
With that, forex traders have a clearer idea of which central banks are dovish and which ones are less dovish. In the recent events, BOE and ECB have emerged to be the most dovish among the major central banks while the Fed is leaning towards tighter monetary policy. In effect, GBP/USD and EUR/USD could be in for longer-term trends in the coming months if the central banks retain their biases.
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