Central Banking and monetary policy are two sides of the coin and mutually influence each other. Each Central Bank is unique and although their influence differs from one another, in general, their roles are the same. In forex trading, the Central Bank has a crucial role and in this article, we will discuss it in more depth. But first, understanding what a Central Bank is is important to understand how it plays a role in online forex trading.
Central Bank? What’s that?
It is the official financial institution of a country and one of its roles is supervision of the monetary system of the country in question. This supervision covers various aspects; interest rates, circulation of official currency and foreign currency, any factors that influence the country’s monetary situation, and so on.
Not all Central Banks are equal. Central Banks of countries with large economic powers have more influence than Central Banks of developing countries. It could be argued that the European Central Bank has much greater influence than the Central Bank of Mexico, for example. Some examples of the world’s main Central Banks are the Bank of Japan, the European Central Bank, and of course the Federal Reserve in the US.
Forex is about currency and one of the effects of Central Bank policy is changes in currency values that occur continuously. The question is how can a Central Bank influence the value of a currency?
The answer is in raising and lowering interest rates!
One of the things only the Central Bank can do is raise and lower interest rates. What do increases and decreases in interest rates indicate? It is the level of demand for money and how much currency is supplied (to meet that demand). The level of demand for money and the amount of currency supplied to meet demand are supply and demand in the forex market. That is the “core of Forex market movements” which means Central Bank policy determines currency movements in the forex market! Of course, this is not the only one, but every Central Bank policy, for example, the Federal Reserve, really determines currency movements. That is why announcements from Central Banks, whether the European Central Bank or the Central Bank of Japan, are marked with red symbols.
Central Bank privileges
The Central Bank as the main bank of a country has special rights. Among them is buying and selling securities on the open market. Buying and selling securities has the effect of changing the amount of money in circulation which in turn will change interest rates. Changes in interest rates mean changes in currency values. They are all related to each other as an unbroken chain of action-reaction. The Central Bank is also authorized to carry out what is called Quantitative Easing (QE). Quantitative Easing is intended to control the value of a currency and is done by injecting liquidity into the financial system. Injecting excessive liquidity can cause the amount of currency circulating on the market to increase uncontrollably and as a result, inflation. Any extreme changes in currency values will appear on the Forex charts provided by an online brokerage platform as a series of very long Bull candles or Bear candles.
In general, what is monetary policy like now?
The global financial crisis occurred 17 years ago and since then there have been massive interest rate cuts by many Central Banks in developed countries which has had the effect of increasingly limiting options for additional cuts. Trying to implement unconventional monetary policies, for example by purchasing long-term bonds to gradually reduce interest rates. When the COVID-19 outbreak occurred, asset purchases and foreign exchange interventions began to increase, and recently, due to increasingly worrying inflation rates, several Central Banks have begun to raise interest rates. The point is balance.
Surprises
There are always monetary shocks and those who can do that are the Central Banks of developed countries, for example, the Federal Reserve, which in the mid-80s suddenly raised interest rates to 10 percent. This policy inevitably caused a domino effect with crazy increases in oil and milk prices. At that time, the Fed’s policy caused economic shocks in many countries and was of course seen as something wrong. Ideally, monetary policy should be implemented gradually to avoid uncontrolled market reactions. In the case of an increase or decrease in interest rates, it is usually done in stages with each stage involving 0.25% to 1%. The reason why monetary policy needs to be carried out gradually is that market reactions are usually much slower than increasing or decreasing interest rates. That is why the true impact of policies related to interest rates can usually only be felt within one or two years after the policy is taken.
Conclusion
It can be concluded that the Central Bank has the greatest influence on the dynamics of the forex market. Every policy will be reacted by the market, and although this reaction tends to be slow, it has long-term implications which of course affect the real movement of candle sticks on the chart.
