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Quantitative Easing and Forex Market
Written by: PaxForex analytics dept - Wednesday, 16 November 2016 0 comments
When an economy is in danger of slipping into a recession or depression, governments can employ a strategy known as quantitative easing (QE). Quantitative easing is an unconventional monetary policy used by central banks to stimulate the national economy when a standard monetary policy has become ineffective. A central bank implements quantitative easing by buying financial assets from commercial banks and other private institutions, thus increasing the monetary base.
Quantitative easing is considered when short-term interest rates are at or approaching zero, and does not involve the printing of new banknotes. The Central markets prints money to finance the purchase of government treasuries from financial institutions in an effort to pour extra money into the economy. The idea is that these institutions will in turn be more willing to lend out money at lower rates, thereby helping the central bank achieve and maintain low interest rates.
If central banks increase the money supply too quickly, it can cause inflation. This happens when there is increased money but only a fixed amount of goods available for sale when the money supply increases. A central bank is an independent organization responsible for
monetary policy, and is considered independent from the government. This means that while a central bank can give additional funds to banks, they can't force the banks to lend this money to individuals and businesses.
If this money does not end up in the hands of consumers, the lending to the banks will not impact the money supply, and therefore will be ineffective at stimulating the economy. Another potentially negative consequence is that quantitative easing generally causes a depreciation in the value of the home country's currency. Depending on the country, this can be a negative. It is good for a country's exports, but bad for imports, and can result in the country's residents having to pay more money for imported goods.
There are two market reactions for fundamental news out there - the instantaneous spike when the news is released, announcing a change, and an eventual adjustment of the price as the announced change starts actually influencing the market. So, what happens when quantitative easing is announced and what happens as it is applied to the market? Theoretically, both would cause weakness in a currency, since more currency is added to circulation - increased inflation - upping the supply and lowering the price.