What is Central Bank Forward Guidance and Why Traders Care?
Central Banks are crucial for financial markets. All their decisions will directly affect pretty much all markets, and especially the foreign exchange market.
They are in charge of keeping balanced import and export rates, promote growth of the economy, and control inflation.
Whenever the central bank of a country introduces a change in its economy, the numbers on the financial markets around the world will go upsides or downsides. Traders are aware of this, so they follow the events closely in order to stay informed and know how to act.
What Is Forward Guidance?
Central Banks make public communication about the state of the current economy, and what would possibly be the outcome for future monetary policy. This communication practice is called Forward Guidance and is significantly helpful for traders.
Forward Guidance gives an estimated path for the interest rates that affect the decisions for making inversions or adjusting the prices on different business. It notes the public about possible changes in the economy; that way, it won’t come as a surprise when it happens. Forward Guidance is now widely used by most of the major central banks in the world, including the US Federal Reserve, the Bank of England, the European Central Bank, and the Bank of Japan.
When Did It Start?
However, Forward Guidance is quite recent. Before 1994, monetary policy decisions were not announced to the public. It made it difficult for the investors to calculate their actions effectively, having to do it by what they could infer from the movement after every meeting.
After 1994, the decisions of the meeting were announced in the FOMC statement released after 2.15pm Eastern time. But, it was not until 2011 that Forward Guidance was made even more transparent by introducing a regular Q&A press conference after every quarterly Fed meeting.
Why Are Interest Rates Important?
One of the jobs of Central Banks is to set interest rates in the country. Depending on the increase or decrease of rates, there will be changes in the valuations on the markets. Investors and traders keep an eye on interest rates because they affect the whole economy and are important for the performance of all financial assets.
For Forex traders, it is crucial to have this information updated. The currency value usually follows the direction of interest rates. If interest rates go up, the value of a currency will increase. If interest rates go down, the value of the currency tends to go down as well.
Forward Guidance and Interest Rates
For those who are interested in getting on board in the Forex market should start to pay attention to Forward Guidance. It is an excellent tool that central banks use to prepare the public for future changes on monetary policy and interest rates.
The central bank provides important information for future policy actions that can become essential for making the right investments at the right moment. They share their outlook on the economy and how interest rates may fluctuate in future months, making it easier for investors to make profitable bets.