Forward guidance

Central banks influence the economy not just through today's interest rate but through what markets expect rates to be over the coming months and years. Forward guidance is the deliberate use of communication to steer those expectations.

Forms it takes

• Qualitative (open-ended): "rates are likely to remain at current levels for an extended period".
• Time-based: a commitment tied to a date, such as holding rates at least until a certain point.
• State-based (conditional): a commitment tied to economic conditions, such as not raising rates until inflation or unemployment reaches a set level.
• Projections: published rate paths, like the FOMC's "dot plot".

Guidance appears in policy statements, press conferences, meeting minutes and speeches.

Why it moves currencies

A currency responds to changes in the expected path of rates. If a central bank signals more hikes than markets had priced, its currency often strengthens immediately, even though rates have not changed. Language seen as hawkish or dovish can move markets as much as the decision itself.

Worked example

Illustratively, a central bank holds rates at 4.00% as expected. Its statement drops the phrase "further tightening may be appropriate". Markets interpret this as the end of the hiking cycle. Two-year bond yields fall 10 basis points and the currency weakens, with no change to the actual rate.

Practical note

Guidance is conditional. Central banks have changed course when data surprised, so treat it as their current intention, not a promise. See central banks and interest rates.