Monetary policy, which is also known as interest rate policy, describes the actions or in-actions of a country’s central banks. Interest rate policy generally focuses on maximizing price stability and growth. The central bank of a country is considered the institution that controls a countries currency, money supply, and interest rates. Central banks also usually oversee the commercial banking system of their respective countries.
Each central bank has guidelines that are mandated by their legislature. For example, in the US, the central bank has a dual mandate which is to maximize price stability and employment. Other central banks, such as the European Central bank, have only one mandate which is price stability.
Central banks often spur growth and employment by reducing interest rates, making it easing for banks to lend money at reduced rates. Lower interest rates also increase liquidity, and make purchasing riskier assets a more attractive alternative than holding low interest baring government notes.
When inflation begins to erode the value of fixed income products, central banks will generally increase interest rates in an effort to cool an economy, and increase price stability.
Decreasing interest rates changes the discounted cash flows of stocks, which in turn increase the value of a stock at the present time. Increasing interest rates has the reverse affect, making the value of a riskier asset such as a stock less valuable.
The currency markets over the long term are driven by movements in interest rates and interest rate differentials. As perceptions about monetary policy change, interest rates with individual countries will change, driving the difference in interest rates between one country and another.
For example, if the US central bank reduces interest rates by either lowering the benchmark interest rate or increasing its currency bond purchase program, while Canada increase interest rates, money will flow into Canadian fixed rate products, and out of US fixed rate products. As interest rates move in favor of Canadian products, the Canadian dollar will gain strength over the long term against the US dollar.
Changes to monetary policy can generate market volatility which can be captured by traders using Binary Options. By using intra-day Binary Options, such as a 60-second option or an hourly option, a trader can speculate on the direction of a currency pair during the period when a central bank is scheduled to release its decision on monetary policy. Changes to interest rates can also generate volatility within the equity markets. While increases in rates usually negatively affect a stock index, declining interest rates usually create tailwinds for stock index prices.
The schedules for monetary policy decisions are available through Magnum Options along with reminders to traders about the timing and the markets expectation of what will likely occur.
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