The foreign exchange market is strongly driven by a set of key factors. While key analysts might argue which economic news is the most important for the market, they will likely agree that central bank rate decisions are very important for both the currency world and stock trading. Today we will discuss the ECB’s interest rate decision trading effectively.
What is the ECB’s interest rate?
ECB is an abbreviation of the European Central Bank, an institution that administers monetary policies within the euro area. In other words, the ECB is one of the biggest controlling powers behind the euro.
The main objective of any central bank, including the ECB, is to maintain price stability within its respective region. The euro is a national currency for 19 members of the Union, which gives the ECB a lot of work to do and automatically makes it one of the most important financial institutions in the world.
In its task of maintaining monetary policies, the ECB has several levers of influence in the global foreign exchange trading scene. One such lever is their monthly release from the ECB’s interest rate.
Central bank interest rates apply to credit conditions for commercial banks within the EU. Normally, every time a decision is made, it has a certain level of effect on most markets, including Forex.
In order to fully understand the mechanics behind the ECB’s interest rate trading economy, let’s see how exactly it affects the market.
How does the ECB rate decision affect the market?
Currency traders can be divided roughly into two fields: technical and fundamentalist. Advocates of technical analysis tend to focus on dry numerical data extracted directly from graphs.
Key analysts, on the other hand, look at factors outside the real market that will affect it in one way or another. According to fundamental logic, most economic events, as well as many political and social events, have a distinctive level of power to impact the price movements of various currencies on Forex.
Therefore, it is not a big surprise, that economic news and reports cause waves of activity in the market. But how exactly does the ECB rate decision trade fall into this?
There are some ways in which the launch of the ECB’s rate decision can shake the market. First, the amounts of volume and volatility increase. As many traders focus their attention on this specific key indicator, the pairs that include the euro become even more active than they normally are.
In the Forex market can be reflected in the EUR / USD pair jumping up to one hundred points, while DAX, an index showing the overall performance of thirty German companies, can change in value up to three hundred points.
As a common effect of the increase in volume, the supply / demand differentials grow more and it usually becomes more expensive to process each transaction. That is why trading the euro with the ECB’s rate decision is not a good idea for novice traders. A certain level of knowledge and skills is required to successfully master this type of trade.
Another reason to seriously treat the ECB’s interest rate decision trading is a riskier environment that always goes hand in hand with escalating volatility. Although there are ways to outline possible scenarios that could take place after the release of the rate decision, there is no way to know for sure how the market will react.
But just before we go into the types of reactions that markets might have to the release of the ECB’s rate decision, let’s take a few moments to break down the meaning of the ECB’s individual rates.
What are the ECB’s individual rates?
It has already been mentioned that the main task of any central bank is to keep monetary policies at bay, mainly by controlling inflation and inducing economic growth within the region.
As indicated in the ECB’s summary of the deposit rate trading economy calendar, this Euro controlling institution has three main tools to help them manage. These tools are interest rates that serve as key factors in the way the ECB influences the market.
The ECB’s main funding rate, for example, is the focus for all commercial banks in the euro area. As a rule, banks are refinanced weekly. The Central bank evaluates the total amount of loans granted by each specific bank and then sets the cost of credit, which translates into the ECB’s refinancing rate.
When the refinancing rate is low, it means that banks will be able to lend to their customers at better rates. And that in turn translates into the growth of local businesses in particular and the European economy in general.
Two other rates, the deposit facility rate and the marginal lending facility rate, create a corridor for day-to-day transfers between banks within the Eurosystem. Both deposit rates and marginal lending rates are pre-set below the main refinancing rate and act as the floor and limit respectively to allow the transactional path between banks.
Apart from the standard key rates, there are also specific measures that emerged in difficult times. During the 2008 financial crisis, for example, the ECB applied several non-standard rates. For example, the full fixed rate allocation was created in recognition of the fact that banks are too dry to lend to each other and, therefore, the Central Bank provided an unlimited credit option at a fixed interest rate.
Understanding rates is important for market analysts, who aim to predict the next reaction of traders around the world who are trading the euro with the ECB’s rate decision. And now, as we know what these rates are, it will also make sense to discuss where they come from.
How does the ECB decide rates?
The decision on the economy of BC interest rates
The post-launch conference is an important event for Forex and stock traders as well as investors from other industries around the world. The speech of the president of the ECB is quoted in all sources of financial means and often becomes the basis of analytical forecasting.
The economic calendar of the ECB’s deposit rate trade is closely watched by all traders basing their decisions on key factors. However, some technicians, such as swing operators, could also pay attention to ECB rates, as it is known to create massive changes in the chart.
Another significant key factors similar to the ECB’s deposit rate trading economy indicators is an announcement from the FOMC, also known as the Fed.
Effect of ECB and Fed announcements
While the ECB is in charge of the euro, the FOMC is in charge of its most common pairing: the USD. Federal Open Market Committee is a twelve-member board, which meets eight times a year. Similar to the ECB’s rate decision Trading, Forex and equities traders around the world are closely watching the Fed’s short-term monetary policy updates.
Both the ECB and the FOMC act similarly, protecting the interest of their national currency in the international trading scene. A general understanding of the economy can significantly help to effectively understand the effect of releasing rate decisions.
It is a commonly known fact that many analysts across the financial scene focus their attention on forecasting the next moves for specific currency pairs. When most analysts come to a similar prediction, something known as consensus is formed. This can be considered as market expectations.
When the release of the rate meets the consensus, those who are negotiating the ECB’s interest rate decision or the Fed’s decision, tend to move somewhat predicatively. A moderate swing will be formed according to the published report. In some cases, the swing will end up being so powerful that it reverses a continuous trend and revives the currency.
However, when the rate interest decision is not in line with most expectations, the chart has a great chance of becoming chaotic. Depending on the discrepancy between forecast and reality, short and rapid changes can begin to form in any direction. These changes will not be as large as when the consensus has been reached, giving operators the hope that the market will soon stabilize.
In general, it is recommended that inexperienced traders stay away from negotiating the ECB rate decision when the consensus did not coincide. Due to the extreme volatility and aggressiveness of the events, there will be a higher level of risk associated with each particular operation. The best way to experience this would be to operate in demo mode right after the ECB published interest rates and most analysts turned out to be wrong.
Now, let’s take a closer look at exactly how different markets react to certain ECB rate decisions, starting with Forex.
How the ECB rate announcement affects the Forex market
How the ECB rate announcement affects the Forex market
Trading the euro with the ECB’s rate decision is extremely common in Forex. For those who are just beginning to understand how fundamental analysis works, interest rate decisions are going to seem very confusing. The easiest way to get started is to understand the following:
Higher interest rates are indicators of a growing economy. The growth of the economy is directly reflected in the increase in the value of the national currency. For investors, this is a time to step in and invest even more funds in the process. In this way the currency is becoming even more valuable and strong and those who invested in it are making profits from their initial bet.
Lower interest rates affect the market in the opposite way. Aggressive inflation is a number one sign of a weak economy. The local currency is becoming less and less valuable. In simple words: twenty years ago, a cup of coffee in the morning would cost you a dollar, and now it is closer to double. As a result, investors retire and seek better opportunities elsewhere.
The main conclusion here should be: even if the rates announced do not agree with your initial forecast, it is still important to keep your hand on the pulse and stay updated with each new release. Because while low interest rates are not ideal for investors, they can revive the economy and basically change the tables for anyone looking to invest.
Perhaps the best solution is to sign up for updates to the ECB’s trading economy interest rate calendar to keep you informed. Now, let’s take a closer look at how different markets react to certain ECB rate decisions, starting with Forex.
Effect of the ECB rate announcement on the securities market
Stock markets can be much more volatile than Forex after ECB interest rates. While numerous opportunities arise along with increasing volume, it is crucial to consider a set of factors during the decision-making process.
Those who are negotiating the ECB’s interest rate decision on the stock market should have a good understanding of the companies behind the indices. Depending on the size, general welfare and interests of the company board, they may have different reactions to the pricing decision.
Again, of course, it is quite possible to successfully negotiate the ECB’s interest rate decision on the foreign exchange and equity markets. But you need to have a solid idea of how this would work and what your exact actions will be.
To do this, you may want to adopt one of the existing trading strategies based on the idea of trading the euro with the ECB’s rate decision. Next, we will talk about two very common methods for using the European Central Bank’s interest rate decision on trade.
Transport trade strategy for the ECB interest rate decision
Carrying is an investment term that can best be interpreted as buying something and holding onto it for a while. In Forex this can be expressed in buying a specific currency at the beginning of its value growth and then selling it for profit once growth slows down.
Transport trade is quite simple and effective. It is based on the concept of high interest rates that we discussed earlier. So, in the scenario where most analysts expected rates to be high, and actually they are, it’s practically the safest opportunity to buy the asset, in our case Euro and see it go up.
And even when consensus didn’t predict it, but rates were still high, betting on the currency can still be a good idea. In this scenario, however, it is better to wait a while until the rapid fluctuation stabilizes. Because, although high rates usually lead to an upward movement, more bears can lead to a downward trend.
The key to mastering the carry trade strategy for the ECB’s interest rate decision is to simultaneously buy the currency at an increased interest rate and short sell another currency at a low interest rate. In this way, the chances of making visible gains are even greater.
It is not uncommon for traders to trade from a few days to several weeks or even months. As long as the value of the currency in which you have invested continues to increase steadily, there is no reason to leave too soon.
However, there are short-term trading strategies that aim to benefit from the publication of the ECB rate report. For example, the trading strategy of the day for the announcement of the ECB rate.
Daily trading strategy for ECB rate announcement
Any day trading strategy focuses on collecting earnings over the course of a day. That is why it is logical that most of the day traders enter and leave within the first days after the announcement of ECB interest rates.
Short-term strategies often vary in style as well as in the ECB’s set of deposit rate trading economy indicators. However, there is one thing that most of these negotiating methods have in common and that is a certain amount of patience.
You won’t have to wait too long to get into the negotiation process, but it’s crucial that you take just a couple of moments watching. Immediately after ECB rates are released, the market will take several minutes to jump across the chart.
As soon as you are more or less stabilized, simply go ahead and involve the steps of any chosen strategy. Whether it is to reduce the scalp of miniature fluctuations or eliminate earnings after each notable swing, the better you understand how interest rates tend to affect the market, the luckier you will have to trade the euro with the ECB rate decision.