Monetary policy announcements and verbal interventions in the Forex market
This lesson will cover the following
- Central bank announcements
- What do we mean by verbal interventions in the Forex market?
- What effects do they have on currencies?
How do central banks announce their policy decisions?
We have already discussed how a central bank’s monetary policy can influence the exchange rate of the domestic currency. Yet one question remains unanswered – in what way does a central bank announce its policy decisions?
Usually, when a central bank’s Chairman, President or Governor makes a statement at a regular or special testimony, such an event may induce huge price movements in the currency market. Such speeches are closely watched; the entire financial world focuses its attention on them, searching for clues as to whether monetary policy will remain on its current course, whether another course will be introduced, or whether any adjustments will be made.
Central banks are very well-organised in terms of their communication with market participants, as they have a predetermined schedule of policy meetings, speeches or testimonies by officials, etc.
Speeches by banks’ policymakers, and especially by governing officials, are thoroughly scrutinised. A central bank’s policy statement is usually presented in such a way that a large transnational corporation or a major investment or commercial bank will, as a rule, appoint a specialist analyst who translates the statement into plain language so that the central bank’s intentions can be clarified. And what about private (retail) traders? Well, in most cases they should stick with the ”larger players in the market” and follow their moves, as the latter will have managed to decipher the announcement made by a central bank.
For instance, Federal Reserve Bank Chairman Ben Bernanke recently said that the bank intended to maintain its accommodative monetary policy for ”an extended period of time”. What could he possibly mean by ”extended period”?
Generally, a statement by any central bank representative is rich in such hints, which need to be translated into real terms and conditions, so that some financial institution may know what actions to expect.
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No straightforward information
A central bank does not issue straightforward announcements, because it does not yet know how the economy will react to its actions or what trends forthcoming macroeconomic data will reveal. If a bank announces today that it will raise interest rates but tomorrow disappointing economic data emerge, policymakers would have to retract the statement. Imagine the consequences for the markets – a disaster. Therefore, central bank policymakers need to be completely confident about the outlook. It is understandable that they prepare global markets for change gradually, by adjusting the tone of their announcements.
Another factor of which beginner traders should be aware is the heightened market volatility during the announcement of a policy decision. If a central bank releases a decision (or statement) that differs from market expectations and overall sentiment, prices can move substantially. There is always a chance that a central bank will change its view of the economic outlook, adjust its expectations and revise its forecasts for major macroeconomic data points (such as consumer inflation, GDP, retail sales). During these times, traders need to be especially careful, control their risk and reassess whether to enter new trades around such announcements.
What do we mean by verbal interventions in the Forex market?
Central banks can also undertake so-called verbal interventions, in which bank officials make remarks that markets are intended to interpret as either supporting or weakening a given currency’s exchange rate.
Central banks usually use these interventions to neutralise mounting speculation among investors that specific actions are about to be taken by the banks themselves. Another reason for such interventions may be the deliberate adjustment of the domestic currency’s exchange rate (especially when the rate is not in line with the specific objectives pursued by the central bank).
For example, during one of his recent speeches, Reserve Bank of Australia Governor Glenn Stevens said that the bank needed a weaker national currency to facilitate the process of rebalancing the economy, because the investment boom in Australia’s mining sector had waned. After such a statement, it is very likely that demand for the national currency (the Australian dollar in this case) would decrease.
The tone used in such statements may also appear more cautious or neutral.