Wednesday, April 1, 2015

Central banks and core interest rates | How they might help in Forex

Sue Trinh, senior currency strategist at Royal Bank of Canada and a stalwart of Bloomberg TV, CNBC and others, has pointed out that it is not the role of central banks to manipulate currency exchange rates. Rather, when rates are changing for one reason or another, it is their responsibility to try to ensure that this happens in an orderly manner so that it does not negatively impact the national economy for which they are responsible. We also know, of course, that central banks are mandated to control inflation and, as in the case of the US Federal Reserve, to support employment levels. An important tool for enabling them to carry out their functions in all these cases is to lower or raise the core interest rate. Because of the importance of the Carry Trade and its global search for yield, changes to the cost of borrowing do, indeed, affect the currency.

Now the former chairman of the Federal Reserve, Mr. Ben Bernanke, has taken the opportunity afforded him by the initiation of his new blog, under the aegis of the Brookings Institute, to provide us with another, related, insight: This is that responsible central banks do not arbitrarily raise and lower interest rates, no matter what the circumstances. Instead, they use the economic research resources at their disposal to calculate what the equilibrium interest rate is, taking into account all the relevant forces that bear on the economy at any particular time, and set this as the rate to be used. Getting this wrong, in either direction, will result in distress to the economy in question.

How they might help Forex trading

According to Jonathan Hilsenrath, writing in the Wall Street Journal, Janet Yellen, the current chair of the Fed, strongly supports Mr. Bernanke’s approach in this matter. It therefore behoves those of us with an interest (no pun intended) in the subject to acquaint ourselves with the factors that might contribute to the equilibrium rate in the US and use this data, as it is released, to possibly inform our Forex trading decisions.

The next question we have to ponder is the stance on this matter that might be held by other central banks. Mario Draghi has often had to defend his and his colleagues’ actions in respect of how they affect the currency exchange rate. He continuously refers to the ECB mandate, which is solely concerned with inflation expectations.

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