The role of monetary policy in the Forex market

Stock Exchange Debate

Any trader in the Forex market must clearly understand what is monetary policy of the Central Bankand what role it plays in shaping exchange rates. Currency and monetary markets are strongly interconnected, so monetary policy is a strong tool for managing the economy. Central banks consider monetary policy as an important element in regulating the main macroeconomic processes - inflation, employment in the labor market and GDP. Two main types are distinguished. hard and soft monetary policies. Consider the advantages and disadvantages of each type.


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Soft ACP is the lifeblood of the economy.

Soft monetary policy is applied when The economy is stagnating or approaching stagnation. Stagnation is characterized by falling production, reduced business activity, rising unemployment and, against this background, a weak currency. In order to correct the negative trend in the economy, The Central Bank should take the following measures:

  • the purchase of government securities on the open market;
  • lowering of reserve requirements for commercial banks;
  • reduction of the refinancing rate.

All of these measures will lead to increasing the supply of money in the economyThis will soon lead to an increase in business activity and, consequently, an increase in the GDP indicator. Against this background, inflationary pressures will increase, but if inflation is below the targeting level - structural problems should not be expected. A Forex trader should understand that if a single state conducts a soft monetary policy, then the currency of this country will become cheaper.

As an example, we can consider the ultra-soft policy of the Central Bank of Japan. The Japanese regulator buys government bonds, exchange-traded funds (ETFs) and real estate funds to the tune of 6 trillion yen every month. All these measures are aimed at fighting the deflationary processes into which the economy of the Land of the Rising Sun has sunk for many years. On the weekly chart of the pair USD/JPY A steady upward trend is clearly in evidence, which indicates that the weakening of Japan's national currency. 

Fig. 1. Weekly chart of the currency pair USD/JPY.
Fig. 1. Weekly chart of the currency pair USD/JPY.

Tight ACP - the key to a stronger currency

Tight monetary policy is applied during the period of stable economic growth in order to prevent the economy from "overheating". To ensure that the players of the real and financial sector do not play with cheap money, the Central Bank applies the following measures:

  • sale of government securities on the open market;
  • increasing reserve requirements for commercial banks;
  • increase in the refinancing rate.

As a consequence, the money supply is decreasingThe growth of credit, investment is declining, and inflationary pressures are being squeezed. Growth refinancing rate increases the attractiveness of the currency as a means of investment. An increase in the discount rate leads to an increase in interest rates on deposits in commercial banks, which supports the demand for the national currency on the part of investors. In this case, we can expect a bullish trend for this currency.

Thus, a trader should always be aware of what monetary policy is pursued by the Central Bank. It is this policy which initiates trends on the foreign exchange market. And as the well-known stock exchange saying says - Trend is your friend!

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