Monetary Policy Announcements and Verbal Interventions

How do central banks announce their policy decisions?

We have already discussed how a central banks monetary policy can influence the exchange rate of the domestic currency. But still one question remains unanswered – in what way does a central bank announce its decision on policy?

Usually when a central banks Chairman or President or Governor takes a statement at a regular or special testimony, such an event may induce huge price movement in the currency market. Such speeches are closely watched, the whole financial world focuses its attention on them in search for clues whether monetary policy will remain on its current course or another one shall be introduced, or are there any adjustments to be made.

Central banks are very well-organized in terms of their communication with market participants, as they have a predetermined schedule of policy meetings, speeches or testimonies by officials etc.

Speeches by banks policymakers and especially by governing officials are extremely thoroughly scrutinized. A policy statement by a central bank is usually presented in such a way that a huge transnational corporation or a large investment or commercial bank, as a rule, appoints a special analyst, who transcribes this statement into normal language, so that central banks intentions can be clarified. And what about private (retail) traders? Well, in most cases they should stick with the ”larger players in the market” and follow their moves, as the latter must have managed to decipher the announcement made by a central bank.

For instance, Federal Reserve Banks Chairman Ben Bernanke has recently said that the bank intends to maintain its accommodative monetary policy for ”an extended period of time”. What could he possibly mean by ”extended period”?

Generally, a statement by any central bank representative is rich in such hints, which need to be translated into real terms and conditions, so that some financial institution may know what actions to expect.

No straight-forward information

A central bank does not make straight-forward announcements, because it does not yet know how the economy will react to its actions and what tendencies macroeconomic data will reveal. If a bank announces today that it will raise interest rates, but tomorrow a disappointing set of economic data eventually comes out, then bank policymakers would have to say that no such action will be taken. Imagine what the consequences for the markets will be, a disaster. Therefore, central bank policymakers need to be 100% aware of perspectives. It is understandable why they prepare global markets to change gradually by changing the tone of their announcement.

Another circumstance, of which beginner traders should be aware of, is market volatility during the announcement of a policy decision. In case a central bank presents a decision (or a statement), which is different to expectations and overall sentiment of the market, this could cause prices to substantially move. A chance always exists that a central bank could change its opinion on economic perspectives, change its own expectations and revise its forecasts on major macroeconomic data points (such as consumer inflation, GDP, retail sales). During this time traders need to be extra careful, control their risk and reassess whether to enter into new trades near the time of such announcements.

What do we mean by verbal interventions in the Forex market?

Central banks can also undertake the so-called verbal interventions, in which bank officials make remarks, that markets are intended to interpret either as supporting or as weakening a given currencys exchange rate.

Usually central banks use these interventions in order to neutralize mounted speculations among investors, that specific actions are about to be taken by banks themselves. Another reason for these interventions could be the deliberate adjustment of the exchange rate of the domestic currency (especially when the rate is not in consonance with specific objectives, pursued by the central bank).

For example, during one of his recent speeches Reserve Bank of Australia Governor Glenn Stevens said that the bank needed a weaker national currency in order to facilitate the process of re-balancing the economy, because the investment boom in Australian sector of mining has waned. After such a statement it is very likely that demand for the national currency (the Australian dollar in this case) may decrease.

The tone, used in statements, may also appear to be more cautious, or neutral.