Our main focus will be on the Bank of England, Monetary Policies, and its Impact on the Forex Market.
What is the Bank of England? The BOE is the central bank of the UK. It is responsible for balancing the flow of cash in the economy with the region’s economic growth. This of course is achieved through the implementation of certain monetary policies, and some other intentional interventions.
In this article, we will be giving an updated explanation of what monetary policies are, what the BOE’s monetary policy is, and how it impacts the Sterling pound and the Forex market in general. So here we go.
What is Monetary Policy?
Monetary policy refers to the official action the central bank of a country or its government can take to influence the value of the price of goods and services in a society. This influence may include setting bank rates and Quantitative Easing.
Central banks use monetary policy to achieve stability in the price of goods and services (Monetary Stability). For example, Central Banks generally try to maintain an inflation rate of 2% to 4%.
A better understanding of Inflation (increase in the price of goods and services) can help to understand the need for control of this price using monetary policies.
High inflation means that the price of goods and services is rising rapidly or unevenly. This means in no time consumers will be unable to purchase some of these goods and services. That is, there will be a decrease in the purchasing power of consumers.
Deflation on the other hand also has terrible effects on the economy. With prices of goods decreasing, there will be no incentive to produce. It could also lead to a reduction in demand as consumers may prefer to wait for prices to drop further in the future before they make a purchase.
Hence the need for the Central Banks to keep inflation at a low and stable value. To prevent these bad economic events.
The Bank of England makes use of monetary policies to keep the prices of goods and services in the country stable. Below, we will explain the Bank of England Monetary Policy
What Is the Monetary Policy of The Bank of England?
The monetary policy of the Bank of England is any regulatory economic action that is taken by this institution, which is not dependent on or influenced by the UK government. The BOE’s independence over monetary policy was put into place on the 6th of May 1997.
So, what is the monetary policy of the BOE? It depends on the current situation of the economy. For example, the BOE occasionally increases or reduces its interest rates to maintain its yearly inflation rate of 2%.
The Bank of England will keep Inflation at this rate to prevent the bad economic situations we explained briefly above.
That is high Inflation and Deflation. This is part of the reasons why experienced Forex traders listen to Forex forecast websites or speculators. They also pay close attention to other news releases like the Manufacturing Indexes, the Non-Farm Payroll news release, and the Consumer Price Index.
How Does the Bank of England Implement Monetary Policy?
As the central bank of the United Kingdom, the BOE uses two main monetary policy tools for implementation.
First, they set the interest rate at which commercial banks borrow money – this is known as the Bank Rate. Second, they strategically buy bonds to lower the interest rates on savings and loans through Quantitative Easing (QE).
The Quantitative Easing monetary policy came into use in March 2009 after the global financial crisis of 2007-2008. It involves the buying of bonds causing their prices to increase.
Bonds pay fixed interest in terms of cash for example $10 per year. This is called its coupon. Whenever the BOE buys government bonds, their prices increase but their coupon remains the same.
For example, for a bond worth $200 with a coupon of $20 per year. That is an interest rate of 10%. Say the price increases from $200 to $210. Its coupon still remains at $20. Hence, the new interest rate is 9.5%. The interest rates of government bonds affect the interest rates of other assets.
Hence, through Quantitative easing, the Bank of England can reduce interest rates of other assets and pump money into the economy by buying bonds.
These two actions increase how much people spend overall, raising the price of goods and services.
Furthermore, monetary policies are created and implemented by a sub-BOE committee known as the Monetary Policy Committee or the MPC. This committee consisting of 9 members first deliberates, through a series of meetings on which policies to make and the ones not to make. Then they announce their agreed policies at the 7th meeting. The MPC makes this announcement once every six weeks.
General Classification of The BOE’s Monetary Policy
Those two monetary policy tools listed above can further be classified into two. They are:
- The Expansionary measures
- The Contractionary measures.
Expansionary measures include stimulating economic activities through the reduction of bank rates, application of QE, etc. Therefore, increasing the rate of employment and inflation.
Contractionary measures, on the other hand, are procedures taken to dampen the economy, reducing the rate of employment, inflation, and money available to the people.
What Is the Monetary Policy Rate of The Bank of England?
The BOE’s monetary policy rate is the current bank rate applied to every commercial bank in the United Kingdom. It is the compound interest expected to be repaid for any pound loaned to any UK bank.
The last change that happened in the BOE’s monetary policy rate was in August 2023. It was risen from 0.1% (in December 2022) to 5.25% (in August 2023)as a result of a significant rise in inflation. Ever since August, the interest rate has remained the same.
So, the current monetary policy rate for the BOE as announced on 1 February 2024, is 5.25%.
For more information on this, you can visit the BOE’s official website
How Does the Bank of England’s Monetary Policy Affect The GBP?
The BOE’s monetary policy affects the GBP through the regular updates provided through the MPC. These updates are provided every six weeks (i.e. eight times yearly). They are aimed at creating a balance between the GBP currency and the country’s economic growth. Here is what we mean.
At this point, you must have known that the UK has a set yearly inflation rate of 2%. So, the BOE occasionally tries to maintain this mandate by regulating its bank rates, and hence the interest rates offered by commercial banks.
In the case of an abnormal rise in inflation, the BOE would increase bank rates causing banks to raise interest rates. This increase would in turn force the businesses and individuals to keep more pounds in the bank. It will also force them to borrow less money from commercial banks.
This is a typical example of a contractionary action, and what it does is reduce the supply of the GBP in the economy, causing a higher demand, and hence increasing its value. The reverse becomes the case if the UK’s inflation rate goes significantly below 2%.
The BOE undergoes a series of deliberations before interfering with the economy. So, the major aim is that there should be a logical balance between inflation and the GDP. This is why you hear terms like Nominal GDP and Real GDP.
Since the Great Britain Pound is one of the major currencies traded in the Forex market, its increase or decrease in value should have effects on the Forex market. That brings us to our next discussion.
How Does the Bank of England’s Monetary Policy Affect The Forex Market?
The Bank of England’s monetary policy has its effects on the Forex market. Being a Great Britain economic news release, it affects the country’s currency, the GBP.
An increase in Interest rates should signify lower Inflation in the future which means a stronger pound. While a reduction in interest rates will mean a weaker GBP.
This should be the case following the Economic policies explained above. But that is not the case. We observed over 2 years of GBP/JPY historical data and noticed several observations.
Firstly, although the Interest Rate was mostly equal to the forecast, the market still reacted to the news approximately 85% of the time.
We observed these reactions to be without pattern or chaotic. Neutral news (forecast equal to actual news) still caused huge reactions in GBP pairs. Negative news (Forecast greater than Actual news) often left huge wicks and were indecisive candles (hammer or doji).
Amidst all the chaos, we noticed that the market retraced its original move during the news release 90% of the time. This resulted in lots of wicks (spikes) during the news release.
The BOE’s monetary policy caused an average of 100.357 pips movement.
We advise traders not to trade during this news release unless they have a working strategy to trade the BOE’s Monetary Policy.
How To Read The BOE’s Official Bank Rate
As a Forex trader, understanding and knowing how to read the BOE’s bank rate is important. This is because it can give you insight into how the rate of inflation of the GBP will be affected, and its corresponding effects on GBP pairs of the Forex market. Below are some tricks to help you interpret the BOE’s official bank rates and trade on them as a Forex trader.
1. Discover When Then BOE Releases Its Updates
It had been explained previously that the BOE releases updates once every six weeks. We also stated that the last time an update was released was on the week of the 1st of February 2024, so the next time to expect an update should be on the 21st of March, noon, Greenwich Meridian Time. Knowing the correct dates for this release helps Forex traders get the news on time and trade accordingly.
2. Compare the Presently Released Bank Rate with That of Forecast Websites
Having known the date at which BOE is to release the next update, you should also take note of the rates predicted by forecast websites as well. This is because It gives you an insight as to how the GBP pairs will be affected in the Forex market.
If the bank rate predicted by forecast websites turns out to be lower than the rate released by the BOE… The value of the GBP in the Forex market is likely to appreciate. But if the bank rate predicted by forecasters is higher than the one released by the BOE… The GBP’s value in the Forex market is likely to depreciate.
This is what is generally expected but may not always be the case.
3. Compare the Present Bank Rate Released by The BOE With the Previous One
This is quite simple. If the presently released bank rate is higher than the previous one, this should indicate an expected decrease in inflation, and hence increase in the value of the GBP. But if it is lower than the previous bank rate, a decrease in the GBP’s value should be expected.
Frequently Asked Questions About The Bank of England’s Monetary Policy
Who Controls the Bank of England?
The affairs of the Bank of England are managed and controlled by 5 top executives. They include a Governor (who is the Chief Executive Officer) and four other deputy governors. The current governor of the BOE is Andrew Bailey.
What Is the Role of the BOE?
The role of the Bank of England is to maintain the health of the UK economy. She does this by taking Expansionary and Contractionary actions on the flow of the GBP currency when necessary. The BOE is also there to act as a lender of last resort to the government in cases where there is no other means of stimulating the economy.
Where Does the Bank of England Get Its Money?
According to a statement released by the BOE on her website, some of her funding comes from printing banknotes. While the other comes from the profit made from selling the printed notes to commercial banks at their face value. The Bank of England then invests this money by lending to the government and gaining on the interest they pay on loans.
Is the BOE's Monetary Policy and Interest Rate A High-Impact Forex News?
Yes, the BOE’s monetary policy and interest rate is a high-impact forex news. This is because any action taken by the Bank of England affects the GBP currency, and the GBP is a majorly traded currency.
Which Currency Pairs Are Affected by The BOE's News Releases
The news releases by the Bank of England are affected by all GBP currency pairs. Below are some of the commonly traded GBP pairs.
GBP/USD, EUR/GBP, GBP/AUD, GBP/CAD, GBP/CHF, GBP/JPY, and so on.
Can the BOE's Monetary Policy and Interest Rate News Cause Spikes In The Forex Market
Yes, the BOE’s Monetary Policy news causes spikes in the Forex Market.
Conclusion
The purpose of this article has been to show Forex traders how the new releases from the Bank of England and its monetary policies affect the GBP currency and the Forex market as a whole.
It is also important to note that the BOE’s news releases are not the only Fundamental news that affects the forex market. There are headlines like the Manufacturing Index news, the Non-farm Payroll news, the CPI news, and so on. So do not base your trading decision on this only, perform other research before you trade.
References
10 Common Effects of Inflation – Investopedia
Why inflation increases with GDP growth— investopedia.com
Inflation and the 2% target— bankofengland.co.uk
Best Forex forecast website— forex.in.rs
2007–2008 financial crisis— wikipedia.com
Nominal GDP vs Real GDP— corporatefinanceinstitute.com