It is said that the value of a currency is reflected by its interest rate. The higher the rate, the better for the currency.

Because central banks set the interest rate levels for currencies on the Forex dashboard, investors view their decisions as significant. Therefore, it is no surprise the main reason investors open and close positions is to adjust their portfolio to accommodate what central banks will decide to do next with interest rate levels.

Based on the currency’s role in international trade and the Forex dashboard, the most important central banks that influence the volatility of the FX market are:

• Federal Reserve of the United States – the Fed
• Bank of England – BOE
• European Central Bank – ECB
• Bank of Canada – BOC
• Bank of Japan – BOJ
• Swiss National Bank – SNB
• Reserve Bank of Australia – RBA
• Reserve Bank of New Zealand – RBNZ

Their corresponding currencies are:

• U.S. Dollar – USD
• Great British Pound – GBP
• Euro – EUR
• Canadian Dollar – CAD
• Japanese Yen – JPY
• Swiss Franc – CHF
• Australian Dollar – AUD
• New Zealand Dollar – NZD

Again, these are the most representative currencies. It is important to remember that behind every currency on the Forex dashboard there is a central bank, setting the monetary policy that influences its value.

The Role of The Central Banks

Central banks meet at regular intervals to assess the state of economic activity. If the economy expands, they look at whether it is expanding at a healthy economic pace, or not, and adjust the monetary policy accordingly. If it is contracting, they make sure to adjust the monetary policy to best stimulate future economic growth.

‘Monetary policy’ refers to all the actions taken by a central bank to comply with its mandate. Typically, the central banks’ mandate revolves around one or more factors that will stimulate economic growth, like inflation and/or job creation.

It is widely known that specific inflation levels stimulate economic growth. It is also well known that job creation leads to a flourishing economic cycle. Therefore, by acting on these two, central banks can fulfill their mandate. Indirectly, they make sure there is a path to sustained economic growth.

Central banks meet regularly, either at six-week or monthly intervals, and they look at the same economic data investors have access to; inflation, jobs data, GDP (Gross Domestic Product), etc. The key is in how investors adapt their positions in light of upcoming interest rate decisions by central banks.

During their meetings, central banks assess the state of the economy, and in the end, they release a press statement. Depending on the importance of the central bank and market expectations, the statement may or may not create volatility in the FX market. For instance, the Fed in the United States meets every six weeks, and the FOMC (Federal Open Market Committee) statement follows the meeting. Because the USD is the pillar of today’s financial system and the world’s reserve currency, the entire FX market moves according to what the FOMC statement shows. The same is true for other central banks, with their overall impact on the FX market being directly influenced by their currency’s significance in global flows.

Take-aways:

• Changes in monetary policy drive the FX market.
• Central banks meet on a regular basis.
• Investors try to interpret the economic data between two central bank meetings and position accordingly.
• By fulfilling their mandate central banks stimulate economic growth.