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.
For instance, Bank of England head Mark Carney talked about the UK central bank's plans to keep interest rates at their current levels for the next couple of years. On the same day, European Central Bank head Mario Draghi remarked that interest rates will be kept 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.
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.
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.
For instance, Bank of England head Mark Carney talked about the UK central bank's plans to keep interest rates at their current levels for the next couple of years. On the same day, European Central Bank head Mario Draghi remarked that interest rates will be kept 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.
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.
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.
Forward Guidance: A Game-Changer In FX Trading?
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