Predicting Interest Rate Changes to Improve FOREX Profits
One of the biggest factors influencing the foreign exchange market is interest rate changes that are made by some of the eight global central banks.
These changes are acting as indirect responses to other economic indicators, and they can potentially move the market sharply and immediately. As surprise rate changes almost always have a great impact on traders, understanding how to react to or even predict these volatile moves can lead to higher profits.
How Rates Are Calculated
Each central bank’s board of directors has control over the monetary policy of its country. This includes control over the short-term interest rate at which banks borrow from one another. Central banks often hike rates in order to curb their inflation, while they cut rates to encourage lending as well as to inject money into the economy.
Typically, the Central bank will decide what to do by examining the most relevant economic indicators; such as:
The Consumer Price Index
Predicting Central Bank interest Rates
A trader can estimate the rate change range by examining these indicators themselves. Typically, as the aforementioned indicators improve, the rates will need to be raised or (if the change is small) to stay at the same level. On the other hand, any significant drops in these indicators should be a sign of a possible rate cut to encourage borrowing.
Major announcements are another way central bank leaders can let people know how the rates will change. Whenever a board of directors from any central bank is scheduled to talk publicly, the news on how the particular Central bank views the current economic position will be revealed.
Traders can also estimate rates by averaging forecasts made by financial institutions, though this estimate would be second-hand and, therefore, less reliable.
Surprise Rate Changes
No matter how calculated a trader is, Central banks can, without any prior notice, deliver a surprise rate change. However, this may not be such a bad thing as the effect on the market is sharp, immediate, and most notably:
If there is a rate hike, the currency will almost always appreciate. Traders should act quickly and buy the currency as soon as possible. On the other hand, interest rate cuts indicate a currency going down in price, and traders should sell or short. Trading trend reversals is also a viable strategy, as the market will most likely overextend while performing a sudden and intense move.