How to Trade the ECB Interest Rate Decision

This is a guest post by Andrew Bezen.

Forex traders look at the economic calendar before the trading week starts. The idea is to find out the most important economic news that influences markets next week and to position correctly ahead of them, or maybe even avoid them. If you take a look at any economic calendar, you’ll find out that the news is grouped into different categories, with the most important economic data being shown in red, the medium impact data in orange and the less important one, or the second-tier data, in orange.

This makes the red data the one to consider. Part of this data, the central bank meetings are the ones that move markets. This is because the value of a currency is strongly dependent on its interest rate. Everyone wants to own a currency that pays a higher interest rate. This is seen even in a trading account if you keep a position open for the night and the swap (the interest rate differential between the two currencies that make the currency pair) is positive. A small amount will be credited to the balance of the trading account.

One of the biggest central banks in the world is the ECB (European Central Bank). The ECB is having a mandate based on future inflation levels: to keep inflation below or close to two percent. The central bank meets regularly to set the interest rate for the period ahead and to adjust the monetary policy. Setting the rates is not an easy task, as the economy is evaluated based on various criteria and a decision is made. The way this decision is communicated to market participants is very important as it may lead to various fluctuation levels.

A fx simulator environment is like trading on an online trading account, but doing it for training purposes. It can be on a demo account, it could be paper trading, but traders that deal with the Euro must consider what the ECB will do.

The central bank used to meet every month, on a Thursday, to assess the monetary policy and to set the rates. Not anymore. Now the ECB meets every six weeks, following the example set by the Federal Reserve of the United States.

In order to trade the ECB interest rate decision, one needs to look at the inflation data released in the six weeks before the ECB meeting and interpret it based on the overall trend. If it gathers momentum, traders will buy the common currency on expectations the ECB will hike the rates or at least will be hawkish when talking the currency.

Believe it or not, the interest rate decision is not the most important part of the ECB communication process. Forty-five minutes after the interest rate is communicated, the press conference starts. This press conference is even more important for the market than the actual interest rate level because traders have a strong tendency to trade future expectations.

I mean, if the central bank raised the interest rate it is bullish for the currency, but if, forty-five minutes later signals that the rate hike was one and done, the currency will be sold eventually.

The press conference has two parts. The first part consists of the ECB President reading the governing council decision, and this takes about ten or fifteen minutes. The rest is dedicated to press representatives from all over the world, asking questions. It is during the press conference that the Euro witnessed high volatility levels, not during the interest rate decision.

Therefore, to position correctly for the ECB meeting and to trade the Euro, one should pay attention to the inflation data (in the economic calendar inflation data is called CPI – Consumer Price Index) and how it is changing: it is getting closer to the ECB target or not. Then, wait for the press conference to see a confirmation of the fundamental analysis and trade accordingly.

You can follow Andrew Bezen on twitter @andrew_bezen    .