Forex market is heavily driven by a set of fundamental factors. While fundamental analysts might argue which economic news matter the most to the market, they will probably agree that rate decisions of central banks are highly significant to both foreign exchange and stock trading worlds. Today we will discuss trading the ECB interest rate decision effectively.
What is the ECB interest rate?
ECB is an abbreviation for European Central Bank, an institution that administers monetary policies within the Eurozone. In other words ECB is one of the biggest controlling powers behind the Euro.
The main objective of any central bank, including the ECB, is to maintain price stability within their respective region. Euro is a national currency for 19 Union members, which gives the ECB plenty of work to do and automatically makes it one of the most important financial institutions in the world.
In their task of maintaining the monetary policies, ECB has several levers of influence on the global currency trading scene. One of such levers is their monthly release of the ECB interest rate.
Central Bank’s interest rates apply to credit terms for commercial banks within the EU. Normally, each time the decision is made it has a certain level of effect on most markets, including Forex.
In order to fully understand the mechanics behind the ECB interest rate trading economics, let’s look at how exactly it affects the market.
How does the ECB rate decision impact the market?
Forex traders can be roughly divided into two camps: technicalists and fundamentalists. Advocates of technical analysis tend to focus on dry numerical data extracted directly from the charts.
Fundamental analysts, on the other hand, look at the factors outside the actual market that will affect it in one way or another. According to fundamental logic, most economical, as well as many political and social events, have a distinctive level of power to impact price movements of various currencies on Forex.
So, it is not much of a surprise, that economical news and reports cause waves of activity at the market. But how exactly does trading the ECB rate decision fall into this?
There are a few ways in which ECB rate decision release can shake up the market. First, the amounts of volume and volatility get increased. As many traders focus their attention on that one specific fundamental indicator, pairs that include Euro become even more active than they usually are.
At the Forex market it can be reflected in the EUR/USD pair leaping as much as one hundred points, while DAX, an index that showcases the overall performance of thirty German companies, can change in value up to three hundred points.
As a common effect of increased volume, bid/ask spreads grow wider and it generally becomes more expensive to process each trade. That’s why trading the Euro with the ECB rate decision is not a good idea for novice traders. A certain level of knowledge and skills is required to successfully master this type of trading.
Another reason to treat trading the ECB interest rate decision seriously is an increased risk environment that always goes hand-in-hand with escalated volatility. Although there are ways to outline possible scenarios that might take place after the rate decision release, there is no way to know for sure how the market is going to react.
But just before we get into the types of reactions markets might have to the ECB rate decision release, we are going to spend a few moments breaking down the meaning of individual ECB rates.
What are the individual ECB rates?
It’s already been mentioned that the main task of any central bank is to keep monetary policies at bay, primarily by controlling inflation and inducing the economic growth within the region.
As indicated in the ECB deposit rate trading economics calendar summary, this Euro-controlling institution has three major tools that help them manage through. These tools are interest rates which serve as key factors to the way ECB influences the market.
The ECB main refinancing rate, for example, is the center of attention for all Eurozone commercial banks. As a rule of thumb, banks get refinanced on a weekly basis. The Central Bank evaluates the total amount of loans given out by each specific bank and then establishes the cost of the credit, which translates into the ECB refinancing rate.
When the refinancing rate is low, it means that banks will be able to provide loans to their customers at better rates. And that in turn results in growth of local business in particular and European economy in general.
Two other rates, the rate on the deposit facility and the rate on the marginal lending facility, create a corridor for overnight transfers between banks within Eurosystem. Both deposit and marginal lending facility rates are pre-set lower than the main refinancing rate and act as a floor and ceiling respectively for enabling the transactional path between banks.
Outside the standard key rates, there are also specific measures that came to existence in difficult times. During the financial crisis of 2008, for instance, the ECB implemented several non-standard rates. For example, the fixed-rate full allotment was created as acknowledgment of the fact that the banks are too dried out to lend to each other, and therefore the Central Bank provided an option of unlimited credit at a fixed interest rate.
Understanding the rates is important for market analysts, who aim to predict the upcoming reaction of traders across the globe who are trading the Euro with the ECB rate decision. And now, as we know what these rates are, it will also make sense to discuss where they come from.
How does the ECB decide the rates?
The ECB interest rate trading economics decision is made by six members of ECB Executive Board and sixteen governors of other central banks in the Eurozone. The decision-making process is held in a form of a vote.
Generally, there are two directions for the ECB deposit rate trading economics indicators, aka the key rates, to go into. As described above, lower refinancing rate and as a logical consequence, lower deposit and lending rates are set when the local economy needs a revitalizing boost.
As the amount of healthy economic activity increases, the Euro grows in strength. For example, a new business, such as a restaurant, will be able to get a loan at a better rate and hire more employees. On one hand, it creates more tax paying jobs in the area, and on the other — paying patrons who bring income and allow the restaurant owner to repay the debt on time.
However, the scenario where the rates increase is also possible. One of the main reasons for setting the key rates higher is to tame the inflation. Inflation occurs due to many various factors, which include the demand for liquidity from commercial banks. When this demand rises, it can negatively affect inflation. That’s why the increased key rates can be necessary.
More often than not, ECB deposit rate trading economics calendar forecast experts are able to predict the next move of the key rates. In order to make such a prediction correctly, an individual trader or a professional analyst have to prepare for the report release. This preparation starts with knowing when to expect the report.
When is the ECB rate decision announced?
ECB rate decision release is a monthly event. On every first Thursday of the month at 1:45 PM CET the rates are published. Shortly after the report publication a press conference with a commentary on the decision is held.
The post-release conference is a major event for Forex and stock traders, as well as for other industries’ investors worldwide. ECB President’s speech is quoted across all financial media sources and often becomes the foundation for analytical forecasting.
The ECB deposit rate trading economics calendar is closely observed by all traders who base their decisions on fundamental factors. Some technicalists, however, such as swing traders, might also pay attention to ECB rates, since it is known to create massive swings on the chart.
Another one of significant fundamental factors similar to the ECB deposit rate trading economics indicators is an announcement from FOMC, also known as Fed.
Effect of ECB and Fed announcements
While the ECB is in charge of Euro, FOMC takes care of its most common pairing: the USD. Federal Open Market Committee is a twelve-member board, which gathers eight times a year. Similar to trading the ECB rate decision, Forex and stocks traders everywhere closely watch the Fed’s short-term monetary policy updates.
Both ECB and FOMC act in a similar way, protecting the interest of their national currency on the international trading scene. General understanding of economics can significantly help to effectively comprehend the effect of rate decision release.
It is a commonly known fact that many analysts across the financial scene focus their attention on forecasting the upcoming moves for specific currency pairs. When the majority of the analysts come to a similar prediction, something known as consensus is formed. This can be looked at as the market’s expectations.
When the rate release complies with consensus, those who are trading the ECB interest rate decision or the Fed decision, tend to move somewhat predicatively. A moderate swing will be formed according to the released report. In some cases the swing will end up being so powerful that it reverses an ongoing trend and revives the currency.
However, when the rate interest decision is not in line with the majority’s expectations, the chart has a really great chance of becoming chaotic. Depending on the discrepancy between forecast and reality, short and rapid swings can start forming in either direction. Those swings won’t be as large as when the consensus has been met, which gives traders hope that the market will soon stabilize.
It is generally advised that inexperienced traders stay away from trading the ECB rate decision when the consensus wasn’t matched. Due to extreme volatility and aggressiveness of the events, there will be an increased level of risk associated with each particular trade. The best way to experience this would be trading in demo mode right after the ECB released the interest rates and the majority of analysts turned out to be wrong.
Now, let’s take a closer look on how exactly different markets react to certain ECB rate decisions, starting with Forex.
How the ECB rate announcement impacts the Forex market
Trading the Euro with the ECB rate decision is extremely common on Forex. To those who are only starting to understand how fundamental analysis works, the interest rate decisions are going to seem very confusing. The easiest way to start is to understand the following:
Higher interest rates are indicators of a growing economy. The growth in the economy then directly translates into the increase in value for the national currency. For investors this is a time to step in and pour even more funds into the process. This way currency is becoming even more valuable and strong and those who invested in it are gaining profit from their initial bet.
Lower interest rates affect the market in the opposite way. Aggressive inflation is a number one sign of a weak economy. The local currency becomes less and less valuable. In simple words: twenty years ago a cup of coffee in the morning would cost you a buck, and now it is closer to twice as much. As a result, investors pull out and seek better opportunities elsewhere.
The main takeaway here should be: even if the announced rates do not agree with your initial forecast, it is still important to keep your hand on the pulse and stay updated with every new release. Because while low interest rates are not ideal for investors, they can revive the economy and basically turn the tables for anyone who is looking to invest.
Perhaps the best solution is to sign up for the ECB interest rate trading economics calendar updates to stay informed. Now, let’s take a closer look on how different markets react to certain ECB rate decisions, starting with Forex.
Effect of the ECB rate announcement on the stock market
Stock markets can be much more volatile than Forex after the ECB interest rate releases. While numerous opportunities arise along with the increased volume, it is crucial to consider a set of factors during the decision-making process.
Those who are trading the ECB interest rate decision on the stock market need to have a good understanding of the companies behind the indices. Depending on the size, general well-being and interests of the company’s board they might have different reactions to the rate decision.
Once again, it is of course very possible to trade the ECB interest rate decision successfully on both Forex and stocks markets. But you do need to get a solid idea of how this would work and what your exact actions will be like.
For this, you might want to adopt one of the existing trading strategies built around the idea of trading the Euro with the ECB rate decision. Next, we are going to talk about two very common methods of using the European Central Bank’s interest rate decision in trading.
Carry trade strategy for the ECB interest rate decision
Carrying is an investment term that can be best interpreted as buying something and holding on to it for a while. In Forex this can be expressed in the purchase of a specific currency at the beginning of its value growth and then selling it for profit once that growth slows down.
Carry trade is pretty straightforward and effective. It is based on the concept of high interest rates that we have discussed earlier. So, in the scenario when the majority of analysts expected the rates to be high, and they actually are, it is pretty much the safest opportunity to buy the asset, in our case Euro and watch it rise.
And even when the consensus did not predict it, but the rates still came out high, betting on the currency can still be a good idea. In this scenario, however, it is better to wait out a bit until the rapid fluctuation stabilizes. Because, although high rates normally lead to upward movement, an increased amount of bears can lead to a downward trend.
The key to mastering the carry trade strategy for the ECB interest rate decision is to simultaneously buy the currency with an increased interest rate, and short sell another currency with a low interest rate. This way the chances of gaining visible profit are even higher.
It is not uncommon for traders to carry a trade anywhere from a few days to several weeks or even months. As long as the value of the currency you’ve invested in keeps steadily increasing, there is no reason to exit too soon.
There are, however, short term trading strategies that aim to benefit from ECB rate report release. For example, the day trading strategy for ECB rate announcement.
Day trading strategy for ECB rate announcement
Any day trading strategy focuses on gathering profits over the course of one day. That’s why it is logical that most day traders go in and out within the first few days after the ECB interest rates announcement.
Short term strategies often vary in style as well as in the set of ECB deposit rate trading economics indicators. However, there is one thing that most of these trading methods have in common and that is a certain amount of patience.
You won’t have to wait too long to enter the trading process, but it is crucial that you take just a couple of moments observing. Right after the ECB rates get released, the market will take several minutes to jump all over the chart.
As soon as it is more or less stabilized, simply go ahead and imply the steps of any chosen strategy. Whether it is scalping from the miniature fluctuations or shaving off profits after each noticeable swing, the better you understand how interest rates tend to affect the market, the more luck you will have trading the Euro with the ECB rate decision.
Trading the ECB rate decision
Basing your trades on fundamental analysis can be very rewarding. However, trading the ECB rate decision requires a good level of preparation. Begin by studying the reports from the last couple of months to a few years.
Then learn to draw parallels between the major political, social and economical events and the ECB decision. The more you practice understanding what might influence the decision of the Central Bank’s board, the better your trading is going to become.
Also, it is always a good idea to get fully familiar with technical analysis tools and tricks, to be able to get solid confirmation from the chart itself. For example, knowing how to recognize a trend reversal from chart patterns can be very helpful during ECB decision trading.
Keep learning and practicing your skills to get a good grasp of trading with fundamental analysis. Feel free to take as much time as needed overlooking how others trade and working out your personal style in demo mode. There is never too much training when it comes to your money being at stake.