[The FX Power Course Staff]

Central Bank: Bank of England Monetary Policy

The Bank of England has two core purposes, one of which is monetary stability. Monetary stability means stable prices - low inflation - and confidence in the currency. Stable prices are defined by the Government's inflation target, which the Bank seeks to meet through the decisions on interest rates taken by the Monetary Policy Committee.

Setting interest rates

As banker to the Government and commercial banks, the Bank of England is able to forecast fairly accurately the pattern of money flows between the Government's accounts on one hand and the commercial banks on the other, and acts on a daily basis to smooth out the imbalances which arise. When more money flows from the banks to the Government than vice versa, the banks' holdings of liquid assets are run down and the money market finds itself short of funds. When more money flows the other way, the market can be in cash surplus. The Bank supplies the cash which the banking system as a whole needs to achieve balance by the end of each settlement day. Because the Bank is the final provider of cash to the system it can choose the interest rate at which it will provide these funds each day. The interest rate at which the Bank supplies these funds is quickly passed throughout the financial system, influencing interest rates for the whole economy. When the Bank changes its dealing rate, the commercial banks change their own base rates from which deposit and lending rates are calculated.

The decisions on interest rates are announced at 12 noon immediately following the Thursday meeting. The announcement of the outcome is made on the wire services' Bank of England pages and on the website.

Decisions of the Monetary Policy Committee are made on a one-person one-vote basis, with the Governor having the casting vote if there is no majority.


Bank of England Dates to keep in mind: (will vary)
MPC Decision: 2nd Wednesday and Thursday of each month
MPC Minutes: 3rd or 4th Thursday of each month
Inflation Report: Middle of each month

Why is this important to me as a trader?

If we view the chart below we can see that interest rates are the primary driver of exchange rates over the long term. As the US was lowering interest rates, aggressively beginning in 2001, the GBP/USD currency pair appreciated from 1.40 to near 1.90. While the Bank of England was also lowering rates, it was not at the same pace as their American counterparts at the Federal Reserve, creating a widening interest rate differential between the two currencies. But then the trend reverses. You will notice that as the Fed began to raise interest rates in June 2004, and the interest rate differential began to narrow, the pair peaked and has now begun to turn lower.

[Student]

I question how greatly the Central bank can influence rates. Surely it has a target rate, and can set the rate at which banks can loan to one another. But presumably, overnight rates are function of the opportunity cost of money. And because money markets are competive markets, (with enough banks so that an indivual investor with a computer can track rates at every major bank) these banks will be competing in order to offer the greatest rates. Look at this link: http://www.money-rates.com/mmarket.htm. There are currently 10 banks offering money market accounts yielding higher than the overnight deposit rate. And this is in a situation where the Governments demand for cash, both to finance trade and to finance a massive deficit out to be causing a major cash crunch; a situation where the fed ought to be the sole liquidity provider. Perhaps I'm making a novice oversight, all feedback is apreciated.

[The FX Power Course Staff]

Originally Posted by Student

I question how greatly the Central bank can influence rates. Surely it has a target rate, and can set the rate at which banks can loan to one another. But presumably, overnight rates are function of the opportunity cost of money. And because money markets are competive markets, (with enough banks so that an indivual investor with a computer can track rates at every major bank) these banks will be competing in order to offer the greatest rates. Look at this link: http://www.money-rates.com/mmarket.htm. There are currently 10 banks offering money market accounts yielding higher than the overnight deposit rate. And this is in a situation where the Governments demand for cash, both to finance trade and to finance a massive deficit out to be causing a major cash crunch; a situation where the fed ought to be the sole liquidity provider. Perhaps I'm making a novice oversight, all feedback is apreciated.

The central bank has a great deal of influence on short term rates not only by setting the target for the overnight rates that banks charge each other (Fed Funds) but also by adding money into or taking money out of the banking system. Anytime you see a financial institution offering more than the going rate, you should put in some due diligence and find out why. I would be concerned about what they were investing the funds in to be able to offer a high rate. With a higher reward there is higher risk, with very few exceptions. Perhaps the fact the long-term rates are still low in spite of the demand for cash by the US Government means that the economic situation is better than is being reported. Successful traders ignore the politically motivated opinion of so-called experts and make trading decisions based on the flow of money, the only opinion that is real.

[Student]

It seems the Federal Reserve is going to stop reporting the M3 in March of 2006. What affect, if any, would this have for the trader in terms of monitoring money supply in your opinion. Also, what goes GBP use as money supply indicators that can be compared to the US system so that money supply can be monitored between currencies. Is this even an imporatant matter to be concerned with?

Thanks.

[The FX Power Course Staff]

Originally Posted by Student

It seems the Federal Reserve is going to stop reporting the M3 in March of 2006. What affect, if any, would this have for the trader in terms of monitoring money supply in your opinion. Also, what goes GBP use as money supply indicators that can be compared to the US system so that money supply can be monitored between currencies. Is this even an imporatant matter to be concerned with?

Thanks.

It used to be one of the most important releases for traders. But since more and more people place their money in money markets and mutual funds and move it around quickly these number have lost influence and importance in the trading world. With central banks becoming more open about their intentions it has lost most of it's luster all over the world. The UK also uses the same reports.

[Student]

"MPC Decision: 2nd Wednesday and Thursday of each monthMPC Minutes: 3rd or 4th Thursday of each month Inflation Report: Middle of each month"

What USD data do I need to compare this information with? I don't understand what to do with this data if I see it.

Where is the best place to see this data? Could you include the web-link where this data can easily be seen?

If you are going to cover this later in the course, please excuse the questions. Thanks.
Edit/Delete Message

[The FX Power Course Staff]

Originally Posted by Student

"MPC Decision: 2nd Wednesday and Thursday of each monthMPC Minutes: 3rd or 4th Thursday of each month Inflation Report: Middle of each month"

What USD data do I need to compare this information with? I don't understand what to do with this data if I see it.

Where is the best place to see this data? Could you include the web-link where this data can easily be seen?

If you are going to cover this later in the course, please excuse the questions. Thanks.
Edit/Delete Message

This is the equivalent of the Fed Meeting Decision and minutes here in the US and would be the comparison to make. You might use daily fx or the IFR news plugin for this information. For the actual interest rate decision you can use Bloomberg.com, or cnbc world, as well. This will be listed as an event in the daily fx calendar which is an invaluable resource.

It is an interest rate sensitive news item, therefore it has the potential to move the market a great deal. Personally, I am a technical trader, so I do not try to “read” into what this or that news story means. However, I am always aware of such events as they might (and often do) act as catalysts for technical set ups.

[Student]

I notice that you talk about some pairs having more corporate activity and less speculative activity such as EUR/GBP and GBP/CHF.

You also mention pairs that have quite a bit of speculators such as GBP/JPY. Is there a list (or way of knowing) which others tend to be more corporately influenced and which ones more speculatively influenced?

[The FX Power Course Staff]

Originally Posted by Student

I notice that you talk about some pairs having more corporate activity and less speculative activity such as EUR/GBP and GBP/CHF.

You also mention pairs that have quite a bit of speculators such as GBP/JPY. Is there a list (or way of knowing) which others tend to be more corporately influenced and which ones more speculatively influenced?

Pairs containing currencies from large developed nations that do direct business with each other tend to have a large number of both speculative and corporate participation. These pairs would include but are not limited to the EUR/USD, GBP/USD, USD/JPY, EUR/JPY and EUR/GBP. We will tend to see more speculators in pairs with a high interest rate differential such as the GBP/JPY and USD/JPY and this will result in higher levels of volatility than we will see with pairs where corporate activity dominates. Keep in mind that we will fin corporations trading in any currency pair that they need to as a result of business practices.