We will look closely in role what they play in the markets.
Central bank is here to make sure that economy stays on track.
We will go deeper so we fully understand their role in the FX markets.
Central banks main job is to control monetary policy and they do this by manipulating the money supply.
This entities are generally considered to be the lender of last resort. When economy is struggling and commercial banks cant cover demand for money Central bank has power with is resources to step in.
In other words central bank is there to stop the banking system as a whole from collapsing.
The primary objective of any Central bank is to provide country's currency and price stability.
It also has regulated authority over nations monetary policy along the sole right to produce and circulate new currency inside that country.
Central banks are completely separated from the government of each nation and their political issues.
Central bank is often termed the Government Bank. They have been around for hundreds of years.
So the central bank plays very important role to the stability of the economy and we will look into each central bank in more detail.
The most important currency in the world is the US dollar making the Federal Reserve the most important Central Bank in the world,
Central bank of each nation is most relevant to each country's currency, but it is very important to understand that most of the time other central banks are watching the FED before making policy decisions on their own.
This makes the FED the big deal in FX market, however the Bank of England, the ECB and the PBOC are also important along with the other banks of western nations.
So lets go through 8 major central banks so we can understand them.
The first bank is Federal Reserve (FED) in the US being the most important bank in the world and having the currency that involved almost 70% of FX transactions each day.
The FED actions can have impact on most of the currencies.
Within the FED there is a group of people called Federal Open Market Committee or FOMC.
This group consists of 7 governers from the federal reserve board and 5 presidents of reserve banks.
The FED mandated is to achieve long-term price stability and sustainable growth and they meet to discuss and change their monetary policy 8 times per year.
The next bank is European Central Bank (ECB).
This bank was established in 1999 and the group of the bank that decides monetary policy is called the Governing Council. The Council consists of 6 members from the board of ECB and governers from each nations central banks.
The ECB likes to provide the market something called Foward Guidance and this means they try to let lots of clues and hints about policy they are going to make and when to minimize market reaction.
Because the more known something is to market the less violent the reaction in the market will be.
The ECB mandate is also price stability and growth but they also want to make CPI growth just below 2%.
Next we have Bank of England (BOE).
The structure is Monetary Policy Committee or MPC wich consist of 9 members.
Governer, 2 deputy governers, 2 executive directors and 4 outside exports.
The BOE is one of the most effective central banks, their mandate is to make monetary policy and price stability.
The BOE monetary policy mandate is to keep price stable and to make confidence in currency.
It has inflation target of 2%, if prices breach that level the central bank will look to curve inflation while the level far below 2% will prompt the bank to boost inflation.
They also meet monthly to discuss and adjust monetary policy.
Next major central bank is Bank of Japan (BOJ).
Their structure consist of monetary policy committee wich is made of BOJ governor, 2 deputy governors and 6 other members.
Because Japan is very dependent on exports BOJ has even more interest then ECB does in preventing strong currency.
The central bank is known to weaken its currency by selling against US Dollars and Euros,
The BOJ is also extremely vocal when it fells concerned by currency volatility and strength.
Its mandate is to maintain price stability and ensure price stability of financial system wich makes inflation cental bank top focus.
The next is Swiss National Bank (SNB)
Their structure is composed of 3 person committee that makes decisions on interest rates.
Unlike the most of the central banks the SNB determine the interest rates band rather then specific target rate like Japan or Eurozone Swiss are also very export dependant wich means the SNB will not have interest in their currency being strong.
Main thing about Swiss is investors see its currency as solid stable thing to invest in wich causes currency to strengthen.
Their mandate is to ensure price stability while taking economic situations into count while being the less active bank.
Next is Bank of Canada (BOC).
Their monetary policy decisions in the BOC are made governing council wich consist of the BOC governor, the senior governor and 4 deputy governors.
The mandate is maintaining the value of the currency. The central bank has inflation target between 1-3%.
Next is Reserve Bank of Australia (RBA)
The monetary policy committee consists of 6 members.
The Central bank governor, the deputy governor, treasurer and 6 independent members
Its mandate is to ensure the stability of the currency, maintain full employment and economy stability.
It have inflation target between 2-3%.
Next is Reserve Bank of New Zealand (RBNZ)
The decision power of making monetary policy is on Central Bank Governor alone.
Its mandate is to maintain price stability and to instability in interest rates and exchange rates.
It have Inflation goal between 1-3% and focuses hard on its target.
Any speeches made by boards or members are important to the market because they have because they have impact on what monetary policy should be.
Each member has a Bias, some of them prefer to keep interest rates low while others think interest rates should be high and that's better for the economy.
One that favor low rates are called Dovs, while the ones that favor high rates are called Hawks.
So we look comments from hawks and dovs that are different from their traditional bias.
For example if a hawk made a speech and in that speech he said he is concerned by economy and how rate cut would be a good idea the market will react bigtime.
Same other way around.
Very often you will see this comments across the news feeds and this can be a great opportunity.
When the economy is doing poorly its usually because money supply is low and the simply way to counter this is to increase the money in the system, if the economy is taking off to quickly this means the inflation got off control and requires restriction over money supply.
The 3 core things central bank can do is:
- Reserve Requirements
- Interest Rates
- Open Market Operations
These are called Reserve Requirements.
FED for example sets reserve requirements for all banks in the US and the other central banks do the same.
By decreasing reserve requirements less money has to be held back wich means the more money can be lent out and injected in the economy.
The next on is Interest Rates, this is where entire FX market revolve around on daily basis.
FED have charge on discount rate wich is the rate FED charges other banks borrow from it.
They also have control over Federal Funds Rate wich is the bank charges each other for overnight loans.
So for example if the FED reduces discount rate the more banks will take money to reloan out and there will be more money in economy.
This works because interest rates are basically the cost of money. So when rates are lowered the cost of money goes down and money supply naturally increases. The problem with reserve requirements and interest rates are results they can take little longer to filter through then central bank would like.
This is where 3 core area comes in of Open Market Operations.
An Open Market Operation is a way affecting money supply by buying or selling securities and mostly Government Securities. So the FED wants to inject money in the market then it will turn to the market and buy Bonds.
When it buys these bonds it gives a sellers of those bonds money wich in turn makes way to economy.
When FED wants to decrease money supply it does so by selling bonds and collecting money in exchange.
Open Market Operations are reserved when urgent actions are needed however they do also engage in more common form of operation. This is knows as overnight repo purchase agreement.
A FED repo basically alters the money supply by very shoer period of time by temporarily buying or selling bonds.
Trader Alen
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