The European Central Bank: A Forex Trader’s Guide

Forex Trader’s Guide

Living in Australia, we often feel ‘safe’ from global disasters. But in the forex world, we’re just as affected by Sino-American trade wars, Brexit, and EU policies. That’s why we need a solid understanding of the ECB (European Central Bank). The 1998 Treaty of Amsterdam established it in 1998, selecting Frankfurt, Germany, as the bank’s home base. Central Banks usually govern their nation’s currency, but ECB dictates policy for all Eurozone members, which include:

  • Austria
  • Belgium
  • Cyprus
  • Estonia
  • Finland
  • France
  • Germany
  • Greece
  • Ireland
  • Italy
  • Latvia
  • Lithuania
  • Luxembourg
  • Malta
  • Netherlands
  • Portugal
  • Slovakia
  • Slovenia
  • Spain

The Eurozone isn’t the same as the European Union. It only covers nineteen countries instead of the 27 EU members not including the UK (#Brexit), and its mandate is to keep prices stable, create employment, and strengthen economies within the zone. The ECB is led by a board president plus five executive board members. The European Council appoints all six members.

The role of ECB

ECB dictates policies that keep prices stable by managing inflation, Euro exchange rates, and HICP (Harmonised Index of Consumer Prices). It aims to maintain short-term interest rates at 2% or lower. There are two main ways to do this. When inflation rises over 2%, ECB might choose to raise interest rates as well. The idea is to tighten expansion, which should have the spillover effect of lowering inflation.

Sometimes, inflation and unemployment rise simultaneously. ECB has to balance its stimulation (lowered interest) and austerity (raised interest) policies for best results. It influences financial stability over the long-term. During an economic crisis, for example, ECB might lower rates to extremes, or buy open market bonds. The latter is called Quantitative easing (QE). Both policies will increase liquidity, allowing ‘more cash’ into the market.

By increasing liquidity, ECB literally keeps the economy moving. A key tenet of forex trader training is the relationship between interest rates and forex listings. This relationship goes beyond action and into expectation. When the market expects a rise in interest rates, currencies fluctuate to match, even before the actual change in interest. Therefore, the ECB can hike or lower Euro prices by forecasting the direction of interest rates.

Effective market correction

Some ways low-interest rates affect the market include:

  • Greater access to business loans, which can be used for expansion and development
  • Deeper stock market discounts, which leads to increased trading, resulting in stock market appreciation and wealth creation
  • Ordinary people realise they can earn more in stocks than sitting idle at the bank in low-interest savings accounts, so they invest more in shares and other financial interests

So what impact should this have on your Forex trading strategy? Here’s an example of how things could go:

What the market expectedWhat actually happenedWhat happens as a result
Interest will go upInterest stays the sameCurrency value drops

Interest will go down

Interest stays the same

Currency value rises

Interest will stay the same
Interest goes up
Currency value rises

Interest will stay the same
Interest goes down
Currency value drops

As an Australian forex trader, the ECB may not seem that important to you. But its policies affect multiple European countries, and the Eurozone has the power to influence other global currencies, so monitoring the ECB should be a major part of your trading strategy.

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