The effects of Quantitative Easing on Forex

The Quantitative Easing (QE) was introduced by the main global central banks as an instrument of expansionary monetary policy, with the aim of stimulating stability and economic growth after the great 2008 financial crisis. With QE, the central bank purchases public (sovereign) and private (corporate) securities to increase the money supply, which in turn should help revive the economy and support the financial markets, lower sovereign yields of government bonds in order to make public finances more sustainable and provide greater liquidity to the banking system, with the intention of having more loans to the private sector.

The effect of QE on the domestic currency is analogous to that of any expansionary monetary policy, a currency depreciation. The logic is simple: a greater quantity of the currency poured into the economy generates an excess supply of that currency and, consequently, reduces its price.

Through the purchase of sovereign bonds, central banks provide liquidity to the market. The increase in liquidity means that interest rates fall and this gives banks an additional incentive to lend. This, at least in theory, is particularly important when interest rates are already close to zero and liquidity on the market is not yet sufficient. However, at least looking at the main macroeconomic data of the economic areas that have adopted QE (Eurozone, United States and Japan), it would seem that the effects of this policy on growth have not been so significant, especially in Europe and Japan. A major concern is also that the short-term benefits of QE may not produce sustainable economic growth and, in the long run, QE only depreciates a currency. This means that while exporters will enjoy increased demand for their goods, importers will see their costs increase, which will be translated to consumers. The inflation rate will also increase. If the economy hadn’t recovered before this increase happened, then a country could experience an economic state known as “stagflation”.

In conclusion, QE is a tool created by central banks to cope with the 2008 financial crisis. In the short term, it has provided some advantage to investors, but, over the years, it is slowly eroding the value of the currencies of nations which have implemented this policy. Few effects were felt on the Forex market, as only the central banks of major economies with relative currencies – such as USD, CAD, GBP, EUR and AUD – took QE measures. These currencies have remained relatively stable for now, but many traders continue to view the QE experiment with great caution. However, currency differentials arose when the Federal Reserve started to raise interest rates again, while the ECB has kept them at zero or negative levels.

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