Whether it’s cutting interest rates or increasing them, central bank decisions have implications for everyone from consumers to investors to business owners and employees. They can accelerate or decelerate the pace of economic growth, influence the inflation rate and affect currency values, among other things. But there are also many other important tasks that central banks must perform, such as communicating policy decisions to the public and managing the flow of money within an economy.
The way in which central banks communicate these policies has a big impact on how markets react. Investors look for clues in the language used, the timing of announcements and broader statements made by the central bank. They pay attention to the make-up of a central bank’s governing council, voting rights and how members are divided when making monetary policy decisions.
Traders also expect central banks to make certain trade-offs between competing objectives in monetary policy. For example, if inflation is running too high, tightening monetary policy (which increases interest rates and limits the outstanding money supply) might help bring it back in line with target levels, but this could reduce economic activity, which would raise unemployment, all else being equal. The same trade-off might occur when a central bank considers purchasing private bonds or assets denominated in foreign currencies.