After the latest round of monetary policy statements, the forex scene was abuzz with the term forward guidance and what it implies for forex trading. Simply put, this is all about the public announcement of what the central bank plans to do with monetary policy and interest rates for the foreseeable future.
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.
Forward guidance is a kind of communication strategy that has been tried out by the US Federal Reserve a few years ago. Back then, policymakers saw the need to give interest rate forecasts, as Bernanke often said that US interest rates will remain at their current low levels for an extended period. In the past month, Bernanke has given a schedule for the Fed's plan to reduce bond purchases, as he clarified that the US central bank could taper stimulus in Q4 and might put an end to their quantitative easing program towards the middle of 2014.
Central bank policymakers implement this kind of communication strategy for two main reasons. One, they want to keep volatility in the local bond market contained. Speculations about interest rates often cause spikes in bond yields, which puts upward pressure on borrowing costs. Giving a specific timeline for keeping rates low calms those speculations down and results in a more stable yield curve. Two, policymakers can make the most of their monetary policy easing program without having to adjust interest rates or boost liquidity. In announcing how long they plan to keep rates low, they are able to influence lending rates among banks and financial institutions for the foreseeable future.
As a result, market watchers are now more aware of which central banks are dovish and which ones aren't. In particular, the BOE and ECB have just emerged as very dovish central banks in comparison to the Fed, which is looking to reduce stimulus soon. With that, forex traders could spot cleaner trends on GBP/USD and EUR/USD.
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.
Forward guidance is a kind of communication strategy that has been tried out by the US Federal Reserve a few years ago. Back then, policymakers saw the need to give interest rate forecasts, as Bernanke often said that US interest rates will remain at their current low levels for an extended period. In the past month, Bernanke has given a schedule for the Fed's plan to reduce bond purchases, as he clarified that the US central bank could taper stimulus in Q4 and might put an end to their quantitative easing program towards the middle of 2014.
Central bank policymakers implement this kind of communication strategy for two main reasons. One, they want to keep volatility in the local bond market contained. Speculations about interest rates often cause spikes in bond yields, which puts upward pressure on borrowing costs. Giving a specific timeline for keeping rates low calms those speculations down and results in a more stable yield curve. Two, policymakers can make the most of their monetary policy easing program without having to adjust interest rates or boost liquidity. In announcing how long they plan to keep rates low, they are able to influence lending rates among banks and financial institutions for the foreseeable future.
As a result, market watchers are now more aware of which central banks are dovish and which ones aren't. In particular, the BOE and ECB have just emerged as very dovish central banks in comparison to the Fed, which is looking to reduce stimulus soon. With that, forex traders could spot cleaner trends on GBP/USD and EUR/USD.
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