As a global marketplace, the forex (FX) market is strongly influenced by both economic and political events. But which ones should you be following?
The pound fell against the dollar on 3 August 2017 before, during, and after the Bank of England’s rate announcement (at 12pm UK time). The interest rate was held at 0.25%, dashing hopes of a rise.
Of course, in practice it’s not quite as simple as assessing a single interest rate. This is because it’s not just the rate itself that matters, but the relative rates between countries. An economy with higher interest rates, for example, is likely to see its currency appreciate compared to countries with lower rates.
And even if there is no rate change, announcements can still have a big impact on currency valuations. Many traders will pore over a central bank’s policy statements to see its assessment of a country’s economic outlook – and for hints of its plans for the future.
However, it’s important to note that forex prices often adjust in the days ahead of an announcement, as the markets get an idea of where rates are headed. Any difference between the expected and actual announcement will therefore have the biggest impact on pricing in the seconds and minutes that follow an announcement.
What to watch
Central banks hold regular meetings to set the base rate of interest for their country, with the aim of hitting a target inflation rate. Their decisions are often announced at scheduled times via press release and press conference. The three key meetings are:
- Federal Reserve meeting: the Federal Open Market Committee (FOMC) meets eight times a year to set the federal funds rate, the base rate of interest for the US. Watch dollar pairs including EUR/USD and USD/CNH.
- European Central Bank meeting: the ECB’s Governing Council meets every six weeks to set the key interest rates used by national central banks in each eurozone country. Watch key euro pairs including EUR/USD and GBP/EUR.
- Bank of England meeting: the Bank’s Monetary Policy Committee (MPC) meets eight times a year to choose the UK’s official interest rate (the Bank of England base rate). Watch sterling pairs including GBP/USD and GBP/EUR.
Other economic announcements
Central banks will assess a number of different factors when deciding if interest rates need to change. So traders will examine various economic announcements, and attempt to predict what central banks might do next. The three most important of these are consumer price index (CPI), employment data, and gross domestic product (GDP).
Consumer price index
The CPI is a measure of inflation. If inflation looks too high, for example, a central bank might raise interest rates to try and counter it – so traders may buy currency in anticipation of a rate change.
CPI is calculated by averaging the prices of a basket of goods and services thought to reflect household spending in a given country. For example, if the rate of inflation was 2% in the UK over the previous year, a basket that cost £100 at the start of the year would now cost £102.
The pound fell against the dollar on 15 August 2017 before, during, and after the UK CPI release (at 8.30am UK time). CPI was 2.6% for July, below the expected figure of 2.7%.
However, CPI data should always be interpreted in relation to central bank policy and other economic factors (e.g. cost of production and raw materials), as rising inflation does not always lead to an interest rate hike.
What to watch
Final CPI figures are released on a monthly, quarterly, and annual basis (depending on country), with preliminary data released in advance. Pay particular attention to:
- Harmonised Indices of Consumer Prices (HICP): this is a measure of inflation across Europe, released monthly. The data is used by the European Central Bank to set interest rates for the eurozone. Watch major euro pairs.
- US Consumer Price Index (CPI): this data represents inflation across the US. It is released monthly, and used by the Federal Reserve to set the target federal funds rate. Watch key dollar pairs.
Employment data releases
Employment data announcements offer an invaluable snapshot of how a country’s economy is performing and changing over time. If more people are employed, there are more individuals with income to spend and invest, so the economy as a whole is likely to strengthen. A better economic outlook often leads to an interest rate rise, so traders may take improving employment figures as a signal to buy.
The markets can react very quickly to employment data, so there are often strong effects on short-term prices as the market adjusts – as well as longer-term price shifts as the effects of employment trickle across the economy. Again, any difference between forecast and actual figures is likely to have the biggest effect on short-term pricing following an announcement.
The dollar rose against the euro on 4 August 2017, following the release of US non-farm payroll data (at 12.30pm UK time), which showed that the US had added 209,000 jobs in July, above the forecast of 180,000.
What to watch
- Non-farm payrolls: this measures US employment in commercial businesses (farm-workers and government, non-profit and private household employees are excluded). Data for each month is released on the first Friday of the following month, and gives a snapshot of how the US economy is performing. Watch dollar pairs.
- UK unemployment rate: released monthly, this measures the number of people over the age of 16 who are without a job, actively seeking work and available to start within two weeks. Watch GBP pairs.
Gross domestic product (GDP) data releases
GDP measures the financial value of all the goods and services produced in a country – another indicator of its economic health. Again, the markets react quickly to announcements, with strong economic performance likely to lead to a rate rise. So there is often an effect on both the short and medium-term prices.
The pound rose against the euro on 24 August 2017, as GDP figures (released at 9.30am UK time) showed that the UK economy had grown by 0.3% in the second quarter (in line with expectations).
What to watch
- US GDP data is released on a quarterly and yearly basis, with preliminary data released at the beginning of each month. Watch for the effects of these releases on dollar pairs.
- UK GDP data is also released quarterly and yearly. Each quarter, preliminary, secondary and final data is released. These releases, especially the final release, have a strong impact on sterling pairs.
Political and world events
World events – scheduled and unscheduled – can have a big impact on forex markets. Political decisions often affect economic stability and growth, so manifesto releases, elections, and referendums often create turbulence in currency markets.
The build up to elections can create political uncertainty. For example, parties could have vastly different economic outlooks, or polls may indicate there is a possibility of a hung parliament. Such uncertainty can undermine confidence in a country’s currency, so traders will often monitor elections closely to identify any trends.
The election result itself often provides more certainty, especially if a political party wins a majority. For this reason, there is often price movement when the election results are announced. Again, many traders will monitor the news carefully to ensure they can react quickly to any election result announcements.
Of course, a government’s economic policies are likely to affect pricing over the long term, so some traders may hold forex positions with the aim of benefitting from longer-term price movements.
EUR/USD fell after the results of the 2016 US election were announced (in the early hours of 9 November 2016, UK time). Traders reacted positively to Trump’s proposed fiscal policies, causing the value of the dollar to rise against the euro.
Other world events
Unscheduled events – like natural disasters, terrorist attacks, or acts of war – can also have a big impact on currency prices. It is often not just the event itself that matters, but how a government handles the situation. Governments that react decisively to unscheduled events tend to provide more certainty, which can help to calm market turbulence, and reduce any negative effect on currency.
EUR/USD rose as the markets priced in the possible economic impact of Hurricane Irma and another North Korean nuclear test (expected over the weekend of 9-10 September 2017). Prices began to recover on Monday 11 September 2017 as Irma was downgraded to a tropical storm and the anticipated nuclear test did not happen.
What to watch
- Natural disasters: these can directly impact the economy by disrupting transport links and consumer spending. Traders often look to sell currency in the aftermath of a natural disaster
- Terrorist attacks: these can have a negative impact on a nation’s currency, as investors look to move their currency holdings into safe haven assets such as gold
- Conflict: this can lead to currency devaluation, again because some investors will look to buy safe haven assets.
Watch our video and read more about what to consider when trading the news.