Even traders who prefer to trade based solely on technical analysis cannot avoid the influence of important news. After all, each piece of news represents a real fact that directly creates or changes trends. Some of the most important news is related to the central banks of countries.
In this article, we will look at the ways in which the largest participants in the foreign exchange market influence trading instruments. This will help beginner traders understand which central bank news deserves the most attention.
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Methods of Influence
As key players determining national monetary policy, central banks have various levers of influence on foreign exchange rates. The most well-known and extensive method is interventions. But besides that, there are many others. Regulators also raise and lower key interest rates, attracting foreign investments and regulating inflation. And most often, they use a technique that economists are accustomed to calling “verbal intervention.” However, let’s discuss everything in order.
Foreign Exchange intervention
Foreign exchange intervention or currency intervention is the most active way for a regulator to influence the exchange rate. The central bank “simply” massively buys or sells foreign currency. Obviously, this changes the levels of supply and demand, causing the exchange rate to rise or fall. Here, it is necessary to say a few words about the fact that there are two main types of exchange rates in the world — floating and fixed.
Understanding the differences between them is crucial in the context of currency interventions. A floating rate is formed under the influence of market forces, such as economic indicators, political situations, and market sentiments. It can experience significant fluctuations. A fixed rate, on the other hand, is controlled by the central bank, which strives to maintain it at a set level relative to foreign currency. For countries with a fixed rate, currency interventions are a necessary tool for ensuring stability.
Changing Key Interest Rates
Almost everyone has heard about interest rates. This concept actually denotes the cost of money within a specific country, that is, the percentage that commercial banks pay to the central bank for using funds. High rates increase investment attractiveness but can cause inflation risks. Low rates reduce investors’ desire to invest in a country’s assets but usually indicate high economic stability. By increasing and decreasing the key rate, central banks achieve the same goals as with interventions — changing exchange rates. Obviously, this method is much simpler technically — there is no need to inject large volumes of money into the market.
Verbal Intervention
But there is an even simpler way. In science, it is called “verbal intervention,” but in essence, it involves someone from the opinion leaders (in this case, usually the head of a specific central bank) giving a speech. It may seem somewhat strange that words alone can have a significant impact on the market. But if you compare currency exchange rate charts with the speeches of ECB and US Fed heads, you will quickly see the correlation.
Of course, such speeches become particularly significant during difficult periods when the market is very attentive and sensitive. But even in relatively calm times, managing information allows central banks to achieve the necessary adjustments in exchange rates, steering the country’s economic policy in the right direction without direct use of financial instruments.
So, we have identified several ways in which central banks influence exchange rates. When studying lists of upcoming news, traders should pay special attention not only to the dates of decisions on key interest rates. Particularly important, especially for those who want to trade on news releases, are specific speeches of the heads and key figures of regulators. Be sure to record them in your trading journal, listen, and monitor the chart of your chosen instrument. It is quite possible that even a short speech will help you open a profitable trade on time and then close it with a profit.
Of course, it is necessary to understand that there are dozens of other sources of information about exchange rates. Timely receipt and thorough analysis of various information about market conditions will help traders get the necessary data to understand major events in the foreign exchange market.
