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9 – Meet the Central Banks

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9 - Meet the Central Banks



Now that we understand what the purpose of a central bank is we should get to know the individual central banks that are most important to the Forex market today.  We will go in order of importance as we see them currently but this could change over time of course.  Exciting!

In this Article:

  •         USA – Federal Reserve (Fed)
  •         Europe – European Central Bank (ECB)
  •         United Kingdom – The Bank of England (BOE)
  •         Japan – The Bank of Japan (BOJ)

USA – Federal Reserve (Fed)

The Federal Reserve is the most influential central bank in the world.  Its currency is involved in an estimated 70% of all FX transactions every single day.  Because of this the actions that the Fed takes can have an impact on most of the world’s currency valuations.

The Fed’s Structure:

Within the Fed there is a group of people called the Federal Open Market Committee or FOMC for short.  This group consist of 1 chair, 7 governors from the Federal Reserve board and 5 presidents from 5 of the 12 district reserve banks.  The 5 presidents rotate through the 12 district reserve banks every couple years ensuring all districts get a vote within a 4 years cycle.

All these people combined make up the Federal open Market Committee (FOMC) and they are definitely a big deal to the FX market so you and I need to listen to what they say and do very carefully.

The Fed’s Mandate:

The Fed’s mandate is to achieve long term price stability of the U.S. Dollar and ensure sustainable growth within the United States economy.  Under normal circumstances, they meet to discuss and change monetary policy 8 times per year. They then release the minutes from the meeting to the public one month later.

The Fed Minutes:

The meeting minutes are a summary of the key topics discussed and the views expressed on those topics.  These minutes are something that the market pays a lot of attention to because there are potential clues in the wording of the minutes that can give traders insights as to what the Fed might do next.

The FOMC discusses and prepares the wording of the minutes very carefully because they want to communicate very specifically to the market what they are thinking and what their intentions are.  They communicate with the market in this way to try and keep price volatility as low as they can. This is communication style is a form of forward guidance.

Forward Guidance:

The Fed uses this thing called forward guidance very specifically.  This simply means that they like to give the market lots of little clues and hints about what potential changes to policy they will make and when they plan on making these changes.  The idea is to minimize aggressive market reactions and control price volatility.

They do this because the more known something is to the market the less violent the reaction will be when the data is released.  Remember, part of their mandate is price stability so this forward guidance is an attempt to accomplish this.

You can read all about what the Fed is currently up to and concerned about on their website.


Europe – European Central Bank (ECB)

The ECB’s Structure:

The European Central Bank, or ECB for short, was established in 1999.  The group within this central bank that decides monetary policy is called the governing council.  The council consists of 6 members from the executive board of the ECB and the individual governors form each of the Euro area member nation central banks.

This means that all countries including Germany, France, and Spain have a spot at the table to ensure their voices are heard.  This ensures that when policies are made they are designed with all Eurozone members in mind. It is important to make sure that no one policy is drafted that will adversely impact a specific member nation but benefits others greatly.

The ECB Provides Forward Guidance:

The ECB likes to provide the market with forward guidance just like the Federal Reserve does.  This is their way of attempting to control price stability within the Euro currency.

The ECB’s Mandate:

The ECB’s mandate is price stability and sustainable growth.  However, they also strive to maintain an annual CPI of just below 2%.  They do this because, as an export dependent economy, the ECB have a vested interest of preventing the Euro currency from getting too high.  This is because having a high Euro value could hurt the exporting companies within the Eurozone. Exporting companies are more profitable if they are being paid with higher value currencies.

ECB Meetings:

The ECB meet most months of the year.  When they make changes to policy they also host a press conference to go along with their statement and explain to the markets why they chose to make certain policy changes.  So as a trader, you know that something important is going to happen if the ECB calls a press conference.

These press conferences will start with prepared remarks and typically have a question and answer session after.  If you are day trading it’s very important to listen out for any questions about monetary policy that may happen because these questions tend to lead to unscripted answers that may be important to your trades.


United Kingdom – The Bank of England (BOE)

The BOE’s Structure:

The structure of the Bank of England includes the Monetary Policy Committee or MPC for short.  The MPC is a 9 member committee consisting of a governor, 2 deputy governors, 2 executive directors, and 4 outside experts.

The BOE is frequently touted as one of the most effective central banks in the world because they have never once defaulted on their debt.  This is impressive because they have had a rather long history on the global financial scene. So for all you Brits reading this, your central bankers have done a good job historically.

The BOE meets monthly to discuss and adjust monetary policy.  If they choose to meet more than once per month then this is an indication that there are some major concerns that the BOE is presently facing.  These are times that us little traders get some really nice trading opportunities with lower risk than normal because price tends to move further and stronger for much longer than it would do under normal circumstances.

The BOE’s Mandate:

Their mandate is to maintain monetary and financial stability within the United Kingdom.  The BOE monetary policy mandate is to keep prices stable and to maintain confidence in their currency.  They want to have confidence in their currency because the UK does business with a huge number of other countries because they have a favourable geographic location for international trade.  To accomplish this they have an inflation target of 2%.

If inflation gets higher than 2% level the central bank will look to curb inflation to a level below 2%.  This will in turn prompt them to again take measures to boost inflation back up when they have achieved their goals.  Most central banks are targeting roughly 2% growth within their economies per year.


Japan – The Bank of Japan (BOJ)

The BOJ’s Structure:

The structure of the BOJ consists of a Monetary Policy Committee which is made up of the BOJ governor, 2 deputy governors, and 6 other members.

They typically meet once per month.  However, they have been known to meet twice per month on occasion if they feel there is enough concern about what is happening within the Japanese economy.

Because Japan is very dependent on exports the BOJ has an even more active interest than the ECB does in preventing its country from having an excessively strong currency.  The BOJ has been known to come into the markets and artificially weaken its own currency by selling Yen against US Dollars and Euros.

BOJ Jawboning:

The BOJ is a particularly vocal central bank when it feels concern for excess currency volatility and strength.  It's very common to hear the members jawbone the Yen currency saying that the price is too high and if it doesn’t come down they will step in and take some action to prevent any further strengthening.

Sometimes the market will trade in line with this language and sometimes it won't.  The way we can figure out how the market will trade is by knowing how much credibility the BOJ has with the market at that time.  If they have not followed through on the last few threats then the market will probably not trade in line with the language. But if they have followed through on recent threats then you can bet that the market will listen and act very carefully.  

BOJ Mandate:

Its mandate is to maintain price stability and ensure stability of the financial system.  This means that inflation is the banks top focus. At the time of this writing Japan has had near 0% inflation for more than 2 decades so inflation is almost always the most important thing to the BOJ.

These central banks are the largest of the G8 and have the most influence over the Forex market.


Up Next:

We are going to look at the remaining 4 major central banks.  They are not as large as the ones we just looked at but they do play a significant role in the Forex market.


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