Currency intervention. What does a trader need to know?

Currency intervention. What does a trader need to know?

Currency intervention occurs when a central bank buys, sells or stimulates the rise/fall of a country's currency in the foreign exchange market. The intervention aims to regulate the exchange rate to a specific level.

Currency intervention can influence movements in either direction, but it's often aimed at keeping the value of a nation's currency lower than that of foreign currencies.

Currency intervention is the regular buying or selling of a nation's currency. This purchase/sale is usually carried out by representatives of the Central Bank of the country where the currency is active. But there are certain types of intervention where the Central Bank of the country itself is not involved in the purchase/sale of currency.

So what are the types of interventions?

Verbal intervention. Also known as "jawboning." The most common type of intervention. It occurs when central bank officials talk about monetary policy, especially raising/lowering interest rates. It is the cheapest and simplest form of intervention because it does not involve using foreign exchange reserves. However, its simplicity does not always mean effectiveness. It usually has a short temporary effect. It is most common among representatives of the US Federal Reserve.

Operational intervention. This is the actual purchase or sale of currency by a country's central bank. Usually, the central bank doesn't specify the date and volume of purchase /sale, so such intervention is often a surprise to traders and investors. Operational intervention is considered an extreme measure of influence on the country's currency system. Therefore, central banks use this type of intervention in rare cases when there is no other way out. There are certain conditions for intervention to be successful. One of these conditions is a considerable reserve of funds of the Central Bank.

Concerted intervention. This occurs when several countries coordinate their actions to appreciate or depreciate a particular currency using their own foreign exchange reserves. The success of an intervention depends on its breadth (number of countries involved) and depth (total volume of intervention). An example of a сoncerted intervention is the G7 meeting which decided to support Japan after the earthquake in 2011. In just a few minutes, the Japanese yen was lowered by two percent thanks to joint action by the ECB, the US Federal Reserve, and the Bank of Japan. Concerted intervention can also be verbal, with officials from several countries joining to express their concern about a continually falling/rising currency.

Sterilized intervention. The most complicated type of intervention. This is when a central bank sells short-term bonds to return excess money in circulation.

At the moment, due to the differently directed monetary policies of the US Federal Reserve and the Bank of Japan, the USD/JPY has risen to a 24-year high. This happened because the national exchange rate strengthens in times of monetary policy tightening and weakens in times of easing. As a result, Japanese policymakers are discouraged by the yen's plunge and are increasingly forced to watch for its recovery. According to many experts, the Bank of Japan and the government are ready to use operating intervention if the yen's fall is too long and rapid. Therefore, traders should be cautious and follow not only the monetary policy of central banks but also the speeches and comments of representatives of these banks.

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by JustMarkets, 2022.07.18

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