Central bank intervention in the forex trading market

Sometimes a currency strengthens or weakens beyond what the domestic economy can bear. When this happens, central bank intervention of some description is likely to occur, in an attempt to remove that inexorable pressure.

Central bank intervention takes several different forms:
•    Verbal intervention. Central bankers may attempt to influence currency flows through statements, either official releases from the bank’s board or casually, in comments made to the media. The effectiveness of this ploy is inversely related to the number of times it’s used, e.g., a central bank that almost never comments on its currency’s rates will receive respectful attention when it does. On the other hand, for a time the Bank of Japan commented on the strength of the yen almost daily, with central bankers and government officials often contradicting each other, and they soon were ignored.
•    Calls to trading desks. The currency trading office of every major bank has a telephone line dedicated for the domestic central bank’s open market desk. That line rings only when the central bank is unhappy with the currency’s rates, and someone rings the trading desk as part of a general enquiry. As this is seen as the last step prior to direct currency manipulation, when that line rings, the entire trading office goes ballistic. Such telephone calls, repeated with trading desks around the world, have been known to halt a too-extreme currency’s move in its tracks.
•    Direct currency intervention. The final weapon in the besieged central bank’s arsenal is to buy or sell its domestic currency on the open forex market. The most recent instance of this was the Swiss National Bank weakening the franc, mostly against the Euro but also against the pound sterling and U.S. dollar, beginning roughly March of 2009. Members of the SNB openly sold francs and bought Euros on the trading floor whenever the EUR/CHF cross approached or fell below 1.5000, as visible on the daily chart, below:

Such direct intervention is truly the central bank’s weapon of last resort. Central banks pay more than lip service to the concept of an unfettered floating currency, and only the direst economic threat will move them beyond calling the dealing desks. It’s also worth noting that, to cause the 600-pip spike on the left side of the chart above, the SNB exchanged massive sums even by the super-sized measures of the forex trading market, an enterprise costly even for a central bank.

Central bank intervention can be:
•    Unilateral by the domestic bank of the currency at stake;
•    A joint action undertaken by the two central banks on either side of a currency pair; or
•    Concerted actions by a group of central banks, as when the G7 united to support the Euro after it collapsed below 0.8500 against USD not long after its debut.