When it comes to central bank decisions, traders need a strong grasp of the market context to understand how these events affect markets. Whether you’re trading stocks, currencies, or commodities, the market shifts that accompany central bank announcements can create opportunities to profit. By combining sector insights with risk management strategies like careful position sizing and stop losses, you can increase your chances of success when trading around central bank statements.
A central bank can change its policy interest rate, thereby changing the quantity of reserves that banks can use to make loans and invest in financial markets. But how does it do that? What is the mechanism through which changes in policy rates are transmitted to other short-term market interest rates?
Prior to 1914, the central banking goals of most independent countries focused primarily on maintaining external stability (keeping an eye on gold supplies and foreign exchange rates) and internal economic stability (focusing on employment, prices, and real output). After World War I, however, these goals shifted, with many countries balancing concerns about foreign exchange and domestic inflation.
The conventional wisdom is that a central bank can influence the volume of money in the economy by changing its policy interest rate, but it cannot control how much money is on the market, or how it’s used. This is a challenge because the financial innovations that emerge in the markets can pose risks for stability, as demonstrated by the subprime crisis.