The Central Bank (CB) of any country is the most important market participant for that country´s currency. The Central Bank officials, with their president/chairman at the top, hold the monopoly for the monetary policy of each country or economic zone. A perfect example of this being the Eurozone. They are the decisive factor for all long-term currency moves. Of course, there are other market participants in the forex market such as investors, speculators, hedge funds, second level banks etc., but they usually drive the market in the short to mid-term.
As a forex trader, it is crucial for you to understand how central banks affect foreign exchanges, as they have the biggest influence driving currency prices up or down. Changes in the monetary policies of a country will strongly impact the demand and offer for its currency, which will then strengthen or weaken against its counterparts. Communication from central bankers is extremely important for traders – especially the one that comes from voting members, as they can give clues about the future path of a given monetary policy. This is why forex traders are usually on high alert and always watching any announcements from the major global central banks.
Central banks have the biggest impact on supply and demand levels for the currency that they oversee. If you purchase an asset in a currency that has a high interest rate, you may get higher returns. This can make investors flock to a country that has recently raised interest rates, in turn boosting its economy and driving up its currency. However, higher interest rates can also make borrowing money harder. If money is more expensive to borrow, investing is harder and currencies may weaken. Central banks can also change the level of money supply. Quantitative easing, for instance, involves increasing the amount of currency in an economy, which will usually cause its value to depreciate.
It is the responsibility of central banks to keep their economy moving in a sustained, yet stable fashion, and as such, they must regulate the supply of money thru monetary policy. The primary means by which the Central Bank performs this is thru intervention and open market transactions. Thru these open market transactions, the Central bank acts to promote economic growth while trying to curb any inflationary effects. And so these activities by the Central bank leads to exchange rate changes. Usually, when a central bank’s Chairman or President or Governor takes a statement at a regular or special testimony, such an event may induce huge price movement in the currency market.
Such speeches are closely watched, the whole financial world focuses its attention on them in search for clues whether monetary policy will remain on its current course or another one shall be introduced, or are there any adjustments to be made. A policy statement by a central bank is usually presented in such a way that a huge transnational corporation or a large investment or commercial bank, as a rule, appoint a special analyst, who transcribes this statement into normal language, so that central bank’s intentions can be clarified. As a forex trader, it is important to keep a watchful eye on upcoming economic releases and speeches from Central Banks.