The Central Bank of any state performs a number of special measures aimed at stabilizing the national currency, which, of course, is a necessary measure to normalize a healthy economic situation in the country. Periodically, a certain country needs special levers of control, and foreign exchange intervention is one of such methods of improving the economy. This is worth talking in more detail.
Levers of monetary policy of the state
The state represented by the Central Bank is able to indirectly influence any economic processes in the country, in particular, during a period of unstable economic situation. The dominant government body is developing principles for regulating situations by approving monetary policy.
What monetary policy is and how its methods are applicable in practice, we described earlier in one of our articles. Therefore, we will only repeat the “passed material” and list the main levers of the monetary policy of any state:
- Interest rates are the most important way to regulate a country's economy. It manifests itself in the revision and establishment of a new interest rate for refinancing commercial banks that are under the “wing” of the Central Bank. With a decrease in this rate, there are more people wishing to obtain credit at a more favorable interest, and, conversely, with an increase in this indicator, loans to individuals and legal entities are reduced. Thus, the state is stimulating or restraining the business activity of the population.
- Change in the required reserves ratio - is manifested in an increase or decrease in the amount of interest-free deposits for commercial banks that are stored in accounts with the National Central Bank. The rate depends on a number of indicators, including the size of the bank. Thus, reducing the rate of this indicator, the Central Bank stimulates economic growth due to the fact that commercial banks are becoming more active in terms of lending to the population. Setting a higher level of this indicator does the opposite - commercial banks lose profitability.
Conducting operations on the open financial market - the Central Bank conducts operations on the sale and purchase of securities in circulation in the state banking system. Thus, by buying up securities, the main regulatory body of the state increases the level of reserves of accountable commercial banks and, by selling securities, activates a drop in banks' money supply.
Currency intervention - a process associated with a one-time or periodic sale or purchase by the Central Bank of a large amount of foreign currency in the relevant market. Thus, the exchange rate of the state is supported.
These are the main methods of influencing the economic situation in the country. And it is worth talking about currency interventions in more detail.
As we already managed to find out, currency interventions are carried out by central banks of states by prior arrangement with large financial organizations (both national and foreign). Through the intervention, the volatility of the national currency is controlled and the volumes of exports and imports increase.
The mechanism of currency interventions is extremely simple and consists of two opposite actions, the relevance of each of which depends on the situation on the market in a specific period of time:
- Currency appreciation. The central bank of the state is actively selling foreign currency, and at the same time, the purchase of national currency is carried out. Such actions increase the level of demand for the national currency of the state conducting the intervention.
- Currency depreciation. In this case, the reverse process occurs to the previous action. The Central Bank makes the sale of the national currency, while buying foreign money. In this situation, the demand for the national currency of the state decreases, and therefore the rate becomes lower.
Types of Interventions
The main types of currency interventions are supposed to be three, namely:
- Direct - The Central Bank does not hide its intentions and notifies prospective and potentially interested market participants in advance that a currency intervention will take place in the near future, as well as in which direction it will be directed (buying up or selling currency). This approach to business allows market participants to prepare for the upcoming event.
- Verbal - an attempt by the Central Bank to influence market sentiment by speaking about a possible intervention. In fact, no events are being held, but such statements by the head of the Central Bank still have a temporary effect. However, realizing that there will be no real action, market participants are "weakening their grip" and the situation in the country is returning to normal.
- Indirect - the procedure for conducting this type of currency intervention is carried out not directly through the country's main financial regulator, but through commercial banks at the initiative of the Central Bank. When conducting an indirect intervention, it is rather difficult to predict the exchange rate and therefore panic sentiments of market participants are not ruled out.
In addition to the main types of currency interventions, there are those that directly depend on the participants in the event.
- Unilateral - implies that the initiator of the event is the Central Bank of the country.
- Bilateral - two countries are participating in the event, one of which needs to strengthen the national currency, and the other, on the contrary, is forced to weaken its currency. This intervention is carried out by agreement of the two parties.
- Multilateral - in the process of conducting an intervention several states are participating at once, which need to adjust the exchange rate of national currencies. It is the most effective way to manage the economic situation of a number of countries.
Intervention and Trading
Carrying out any activities on the part of a state whose currency is used in trading at the Forex market, one way or another affects the mood of the market and the behavior of assets. Some brokers still try to convince market participants that the quotes are predictable and by analyzing the data it is quite possible to predict how this or that asset will behave. But in reality, everything is somewhat different. Forex is really predictable with an accuracy of 70%, in rare cases up to 90% - during periods of a calm market. In other cases, the market is chaotic and foreign exchange intervention will undoubtedly affect the fluctuations of exchange rates.
That is why, when trading on Forex, a trader should not neglect the statements of the heads of the central banks of leading countries, especially if the national currency of these states is part of a currency pair traded on the market at a particular time. It is possible that a trend reversal is possible, which can especially affect the opening of a market position. In addition, as one of the main effective levers in the market, foreign exchange interventions can set exchange rates. It can also be in the hands of scalpers who are ready to “go” into the world of trade for a while and make a number of short-term transactions in the hope of profit from the price difference of resold currencies.
Basically, an ordinary trader is quite capable of independently predicting the intervention, because a number of factors contribute to this event. Having experience, it is quite possible to determine covert intervention, which is not actually announced. The main thing is to realize exactly what type of intervention is present on the market, because, for example, verbal intervention can deceive the expectations of traders and play against them.
Author: Kate Solano, Forex-Ratings.com