Central banks and monetary policy

Central banks and monetary policy

Everyone involved in the stock markets keeps a close eye on monetary policy reports when central banks have a meeting and what the outcome will be. Every time there is a meeting of central banks volatility increases rapidly and money can be won or lost very rapidly as prices fluctuate considerably. All stock markets are influenced by monetary policy decisions because the interest rates charged by central banks affect both stocks, bonds and currency markets.

The major central banks to keep an eye on are:
– Federal Reserve (Fed)
– European Central Bank
– Bank of Japan
– Bank of England

It is important to look at the economic calendar when central banks organize a meeting in the main economic regions.

Monitor monetary policy meetings

Federal Reserve – Global monetary superpower

The largest central bank in the world, the Federal Reserve in the United States, holds a meeting every six weeks on Wednesday and the traded volume of the US Dollar on that day is huge. So if you are trading binary options on a currency pair including the US Dollar, you should know that these Wednesdays will probably be the most volatile.

European Central Bank – same currency for 18 countries

The ECB (European Central Bank) hold a meeting on a monthly basis and the Governing Council eventually determines the interest rates. The meeting takes place on the first Thursday of the month and the Euro exchange rate is moving all over your screen when such a meeting takes place. However, the ECB and the BOE (Bank of England) are changing the way they interact with the markets. Even the Fed does, so let’s have a look at each of them and find out what changes they make and how we, traders, should react.

When does the ECB meet?

First of all, the ECB no longer meets every Thursday and no longer meets on a monthly basis either. The press conference and interest rate decisions nowadays are held on Wednesdays and every six weeks instead of monthly.

More importantly, the ECB is copying the American model. The intention is that the ECB should publish keynotes about the previous meetings and the whole process is intended to bring more transparency into the monetary policy and central banking activities.

The most important thing of an ECB meeting day is not the actual interest rate decision, but the subsequent press conference and the reaction of the market.

Structure of an ECB press conference

During a press conference, the first part consists of the reading of the statement and the second part is for journalists to ask questions. Of course you never know in advance what questions will be asked and how these questions will be answered. Normally the price action on euro-related currency pairs is impressive during such a press conference.

Bank of England – Home of the Pound

The smallest of all major central banks has been changing most. The first non-British Bank of England Governor (Mr. Carney is Canadian) has changed the way the bank operates and communicates. When the MPC (Monetary Policy Committee) meets on a monthly basis, no statement is published if there is no change in interest rates.

This makes the whole event quite boring as for the last seven years nothing has changed in the interest rates. However, there are other channels through which it communicates with the markets, one of them being, for example, the Inflation Letter which is published by the Governor of the Bank of England to communicate his intentions to the market.

FOMC meetings cause volatility

In the United States the Federal Reserve’s monetary policy already changed from the day they introduce their forward guidance policy. Since Mrs. Yellen, the current Chairwoman, has the top function, the course of business has changed dramatically.

Although the Fed still holds its meetings once every six weeks on Wednesday, there are some interest rate decisions and FOMC (Federal Open Market Committee) decisions which are not followed by a press conference. Usually they do not really move the markets. However, when a press conference does take place, volatility rises and prices become more unpredictable.

To conclude this article I want to reiterate the many changes in monetary policy as this is the essence of the trading the financial markets. Changes happen all the time and in order to trade successfully one needs to be informed 24/7, both from a fundamental and from a technical point of view.

Read other education articles in our Education Center

Read specific binary option strategies in our binary option strategy catalogue

Continue reading: Plus500 lesson 1: Forex trading at Plus500