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Major Central Banks and their Role in the Forex Market

What are central banks and interest rates? How do they influence the Forex market? What are their roles and key responsibilities in the global financial ecosystem? These are the questions many beginners ask when starting trading currencies and some other instruments. The entire system of central banks is quite complex. The first and foremost thing you need to know is that they are responsible for keeping the nation’s monetary system under control.

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Besides, central banks have other specific tasks and obligations such as keeping the nation’s currency stable, lower inflation or improving the employment rate in the region. Also, they appear to be the main currency issuers in the country. Central banks regulate interest rates and credits, supervise commercial banks, keep exchange services and platforms under control, etc.

However, what is the role of central banks in the Forex market? This is what we are going to find out today.

What Are Central Banks?

But first, we need to clarify some key aspects of these financial and regulative institutions. To keep the situation and market under control, central banks use the following major tools:

  • The central bank rate – also known as the federal fund rate, it is used to keep control over the nation’s economic activity (either to increase or decrease it). The monetary policy committee usually sets this rate depending on the financial situation in the country and across the world.
  • Open Market Operations – OMO is the process of selling or purchasing binds, stocks, and other securities by the government in the open market. The main goal here is to keep the fund volume of the national banking system under control.

Often, central banks serve as last resort lenders to keep investors confident about the fact that their financial obligations will be met and fulfilled.

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The Main Responsibilities of Central Banks

They can be different depending on the country along with its economic and geopolitical situation. However, the main goal is to meet public interests. The key responsibilities include:

  • Keep the financial system stable and protect currency values.
  • Achieve and promote stability of the financial system by reducing the risk of the financial sector.
  • Ensure sustainable economic growth through interaction with commercial banks and other financial institutions, proper Fiscal and monetary policy, and other methods.
  • Manage, supervise, and regulate other financial organizations and institutions to make them follow public interests.
  • Increase the employment rate and take measures to minimize unemployment.

3 Major Central Banks across the Globe

Here is the list of globally recognizable central banks that play a huge role in the worldwide economic formation as well as in the Forex market:

  1. Federal Reserve System (FED), USA – one of the most influential banks observed by traders from across the globe.
  2. European Central Bank, EUR – it regulates the economy of not just a single country but all members of the EU.
  3. Bank of England, GBP – the UK’s central bank operates to follow the two main objectives, which are financial and monetary stability.

Of course, those are not all of the most influential central banks. As a Forex trader, you will also need to consider the central banks of Japan and Canada, Swiss National Bank, reserve banks of New Zealand and Australia, etc.

The Way Central Banks Set Interest Rate

Central banks set not only their interest rates, which refer to commercial banks eager to borrow funds but also those referring to individual loans, credit cards, etc. Commercial banks often borrow money from central banks in case they do not have enough funds of their own to comply with Fraction Reserve Banking in its modern form.

Besides, commercial banks need funds to ensure a stable money flow to provide credits, let clients withdraw enough cash, payout investors’ commissions, and more. They usually establish interest rates that are higher than central bank interest rates, as this is the only chance for commercial organizations to generate profits.

For this reason, Forex traders always keep an eye on the interest rate changes, as it can have a significant effect on the FX market.

The Effect of Central Banks on the Forex Market

Traders are always in search of clues and pieces of evidence of the central bank chairman’s immersion to decrease or increase the interest rate. This is where you will have to learn several terms that will help you to interpret the information correctly.

The first term is “Hawkish”. It refers to central banks that plan or just about to increase the interest rate.

The term “Dovish” means that central banks are planning or just about to cut down on the interest rate.

When you hear the term “Quantitative easing”. It means that central banks are planning to purchase long-term bonds from some of their holdings. It will lead to increased demand in those particular bonds. 

This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.