What is Monetary Policy
The central bank's playbook — rates, QE, forward guidance
- Name the three main tools of monetary policy
- Explain why forward guidance often matters more than the rate itself
- Read a CB decision through its tool kit, not just the headline
When the Fed cuts 25bp, GBP/USD might move 50 pips. When the Fed *signals it will cut faster than expected*, GBP/USD can move 200 pips. The signal often beats the move — because markets price the path, not the event.
Three tools, one goal
Central banks have three levers: (1) policy rate — the price of money. (2) Quantitative easing/tightening — the quantity of money (buying or selling bonds to expand/shrink reserves). (3) Forward guidance — telling markets what they'll do next. All three serve one goal: keeping inflation near target while supporting employment.
Direct, blunt. Hike to slow demand, cut to stimulate. Effects take 6-18 months to show in real economy.
Free, surgical. CB tells markets the expected path; markets price it; long-term yields adjust immediately. Often more powerful than the actual rate change.
Why guidance matters most
Markets are forward-looking. A Fed that cuts 25bp but signals 'no more cuts coming' is hawkish. A Fed that cuts 25bp but signals 'much more to come' is dovish. The currency reacts to the path, not the single move. This is why CB press conferences move FX more than the rate decision itself.
Fed cuts 25bp but Powell signals 'this may be the last cut this year.' Likely USD reaction?
- Three tools: rate, QE/QT, forward guidance
- Markets price the path, not single moves
- Press conference often beats the decision itself
- Hawkish guidance = currency up, even when CB cuts
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