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Central banks do not often intervene in the forex market. But they do intervene at time, especially when there’s a significant economic weakness in the currency. As a result, any intervention by a central bank usually only happens when the currency is under some sort of a serious crisis.
In this article, we list down the ways in which a central bank intervenes in the forex market. If you want to learn more about the inner workings of the forex market, you should read this.
Jawboning
Jawboning is one of the most basic methods that central banks use to manage their foreign exchange reserves. As the name suggests, this jawboning technique is more about talking than actually doing anything.
When the central bank uses this technique, it starts talking about their target currency levels and tell the media that an intervention is possible from their side if the currency goes beyond or outside a certain point or other conditions are met.
The traders and other participants in the market are aware of the might of the central banks and thus the currency range declared by the central bank tends to be the range within which the currency starts trading without any actual intervention from the central bank.
Operational Intervention
Another technique that is used to control the currencies’ exchange rates is called the operational intervention. This is what we usually refer to when we the term central bank intervention. Using this method, the central bank actually steps into the market and starts buying and selling currencies according to the goal of driving the exchange rate up to a particular point.
Traders are worried about central bank intervention since the objective of a central bank is not to make money while trading. This means that an operational intervention can also result to a substantial dent in the forex reserves of the central banks. This is why this method is usually sparingly used.
Concerted Intervention
A concerted intervention is like combination of jawboning and operational intervention. Firstly, as the name suggests, concerted intervention requires the concerted action of multiple central banks. Therefore, multiple central banks begin jawboning specific currency rates in the market.
Then, as a part of the concerted intervention, of these coordinated central banks may actually begin operational intervention to correct the currency rates while the others increase their jawboning activity. In other words, the forex market is under threat of action from several central banks in one go.
Sterilized Intervention
A sterilized intervention is another form of operational intervention by central banks. In this method, the central banks perform operations that affect the currency rates in the forex market. However, it takes measures to ensure that none of the activities in the market have any effect on the trade or commerce in its home country. In other words, it “sterilizes” the intervention as far as the country is concerned.
There’s a side effect in this policy, however. The number of dollars in the United States economy would suddenly increase as a result of this transaction. This could cause inflation and other economic situations. To counter the situation, the Fed would sell USD-denominated bonds in the market.
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