FED and ECB impact over the fx rate movement- magazine Economy and Business


author: Vladimir Trajkovik

Decisions made by the Central Banks from the globe largest countries (that have large effect over the all global economy) and that are in relation of setting the height on the basic interest rates creates significant impact primarily on the prices of the governmental securities and consequently over the prices on the most traded world currencies.
Managing the basic interest rates represents one of the most significant instruments of the monetary policies established by the global Central Banks. Central Banks through the process of sublimating the analyzed data for financial and macroeconomic flows, above all at the local markets and putting them in correlation with the strategic aims make decisions that determine the height of the basic interest rate on the regular basis and by the strictly predefined calendar. In the focus of the world developed economies and particularly in the frame of the developing economies, besides the domestic central banks, always with great attention are followed the decisions made by the American FED and European Central Bank ECB.
Last declining of the federal funds interest rate from the previous month for 25 basis points (first, after 2008) at some point was expected, having on mind previously announcements from the FED by itself but also from the pressure that president Trump perpetually perform over Federal Reserves.
Namely, the White House for a long time is leading a campaign for weakening of the American dollar in the light of the current global economic movements and trade war between USA and China. The president Trump in his last statements has commented that lowering of the interest rate of the federal funds is insufficiency and that FED should consider into the direction of providing the assistance to the American businesses. ,, In this moment FED has holding us with hands tied” – has commented the president Trump and stressed out that FED should take under consideration to decrease the interest rate for whole percentage point.

Thence, the comment that lowering the interest rate is to some extent expected, or that was expected FED to decrease the interest rates at least for the half percentage point.
At the other side, the message from the American market governmental securities is that the investors are unstoppable in investing in them. Certainly that is justified with having on mind that the yield (income) and risk in relation to the other instruments is more than clear and is directed toward FED – prices of the GS should raise and the yields (incomes) should fall. In such course are the expectations that FED at the next committee of FOMC that is scheduled for 18 September will bring decision for further releasing of the macroeconomic policy and lowering the interest rates.
Graph 1 – FED movement in correlation with the movement of the price dollar index (source: Refinitiv, Eikon)
On the other side of the Atlantic, European Central Bank, leads basic politics of providing sustainability on the price stability and have targeted low, below, but near 2 % inflation rate. In aim to address the problem with the extended period of law inflation rate with digit of far below 2 % (far away with digit below 1 % in the period of the 2014 -2016) ECB has launched the Programs for redemption of bonds (Asset purchase programs) as well begin to diminish the crucial deposit interest rate, that from the middle of 2015 is in negative zone.
Last statement of the President on ECB, Mario Draghi, from this July is that the expectation for fluctuation of the key interest rates till the end of the year and first half of 2020 is the same to move on the same or lower level and that leaves room for further possible decreasing of the rates. In addition of this is also the movement of the 3 monthly EURIBOR that for the first time in the history fall below the level of the key deposit interest rate ( -0,404 % against -0,40 %) as effect of the bank expectations for possible lowering that ECB has announced in July with aim to be realized already in September.

Graph 2 – Movements of the Deposit interest rate of ECB in correlation with the movement of the price of euro index (source: Refinitiv, Eikon)
Undertaken changes over basic interest rates of the FED and ECB have direct impact not only over changes of the foreign exchange course of the dollar and euro, but also have changed the remain world currencies, particularly on the currencies in the developing countries.
Every increasing on the interest rate of FED or ECB causes increased interest at the investors for investing in governmental securities in to the subject currency (USD or EUR) and for that reasons enlarged demand has appear and foreign exchange currency course that is subject of investment notes growth. Vice versa, if the basic interest rates notes fall the investors sell the governmental securities in the subject currency (USD and EUR) so it is appearing the largest offer of the currency which foreign exchange rate fall.
Increasing or decreasing of the foreign exchange rate of the USD or EUR influences over remaining currency in the opposite direction. If the foreign exchange currency of the dollar is strengthening (for an account of the dominical currency that weakness) the same will cause price increase of the imported goods from USA in the other countries, that in last instance will cause inflation and vice versa.
From such reasons, the Central Bank of the countries that are import depended from dollar goods or that servicing liabilities (debts) in dollar, mostly decided to the adjustments of the domestic interest rates on the movements on the key interest rates from FED in aim to neutralize the effect of changes of the same and to kept the foreign exchange course on the acceptable level.
In the end, if the statements of the FED and ECB and the plan of the White House and the president Trump are taking under considerations it is more than obvious that in September it is expected to have further releasing of the monetary policy of the two major Central Banks.
It is real to expect decreasing of the interest rate of the federal funds between 25 and 50 basis points and decreasing of the key interest rate on the deposits of the ECB for 10 to 50 basis points.
In that context are the predictions that the foreign exchange course of the EUR/USD will move in range from 1.12 -1.13 in the third quarter for further weakening of the dollar in range from 1.14 -1.15 dollar for one euro until the end of the year.

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