I have always found the relationships between central bank decisions and consequent currency movements to be very interesting. I was unaware when I was starting Forex Trading the effects the comments by central bank officials can have on currency values, in some cases more than the actual rate-change decision.

The Major Central Banks of the world each have their own characters. People can usually predict their behavior in various circumstances based on who is in charge, or the decisions they have made in the past. For instance, it is well known that the European Central Bank is generally against dropping Interest rates to very low levels, if they can help it.

In normal markets, lowering interest rates generally reduces the value of a currency, as the return rate of owning or investing is now less. This also raises the possibility of issues with inflation. There are valid reasons for reducing the value of a country’s currency. Exports are a good one. When a country’s currency is strong, other countries have to pay more for any products they wish to acquire from the country. This might be good when things are alright, but when a recession comes along, the you start to have real problems. People might go to places where they can pay less.

During this time of economic turmoil, Japan’s currency has risen in value considerably. While it might be for a variety of reasons, it still raises issues for them since they are a large exporter. China is another example. They basically allowed their currency to stay quite low in value via a technicality which we can’t get into right now. The end result was that they managed to keep their export industry relatively competitive. It prompted the US Treasury secretary to accuse them of a artificially fixing the value of their currency. Unfair tactics, they claimed. At the following meeting of the G8, some people even expected that they would say something to China about it. No one did, Even the US took a softer stance. All of this highlights how controlling currency rates can be critical.

Central Banks Rate cuts are used as a weapon during a financial crisis such as this one. It helps to ease rates for businesses who need to borrow money to stay afloat. It gets money flowing a bit more. However, there are times when the effects are skewed. Let’s return to the example of the ECB above. Late in 2008, and again early 2009, investors awaited currency rate decisions from the Central Bank of England and the ECB respectively. As we said above, a reduction in the rates tends to have a negative effect on the currency’s value, at least in the short-term. However, when the CBE cut rates aggressively, it had the opposite effect on the British Pound. The value increased because people felt that the CBE would do all it could to fight the recession, and by implication help the British economy recover faster. A strong economy is needed to support a strong currency. The ECB rates should have had similar effects on the Euro,but it didn’t. Investors didn’t believe that they had cut rates far enough. Therefore, they were unwilling to go all-out to fight the recession. The Euro lost ground. Even though this loss would be the general expectation in normal conditions, in that economic climate, more aggressive cutting would have had the opposite effects.

It’s a fine line that central banks have to walk when they make these decisions. When a rate decision meeting approaches, investors and traders (of all kinds, Forex included) try to make an informed guess where rates will go, and consequently what the effects will be on the market. Needless to say, it doesn’t always go as planned. This is a hazard of trading.

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