Central bank intervention refers to the actions taken by a country's central bank to influence the value of its national currency or stabilize financial markets.
These interventions typically occur in the foreign exchange (forex) market and may involve:
- Buying or selling foreign currencies to affect exchange rates.
- Adjusting interest rates to influence capital flows and currency demand.
- Issuing public statements to shape market expectations (also known as "verbal intervention").
Here’s an example of central bank intervention in practice:
Example: The Bank of Japan (BoJ)
Suppose the Japanese yen becomes too strong against the U.S. dollar, making Japanese exports more expensive and hurting the country's export-driven economy. In response, the Bank of Japan might intervene by selling yen and buying U.S. dollars in the forex market. This increases the supply of yen and raises demand for the dollar, which helps weaken the yen and strengthen the dollar.
This action can make Japanese goods cheaper abroad, boosting exports and supporting Japan’s economy.
A real-world example of central bank foreign exchange (FX) intervention occurred in Switzerland in 2011. The Swiss National Bank (SNB) intervened in the FX market to prevent the Swiss franc (CHF) from appreciating too rapidly against the euro (EUR).
Context:
- During the European debt crisis, investors sought safe-haven currencies, and the Swiss franc was seen as one of the safest currencies in the world. This caused the Swiss franc to appreciate sharply, putting Swiss exporters at a significant disadvantage and threatening to hurt the country's economy.
- In September 2011, the SNB set a minimum exchange rate of 1.20 CHF per euro to protect the Swiss economy from the overvaluation of the franc.
Intervention:
- The SNB directly intervened by buying large amounts of foreign currency, particularly euros, to flood the market with Swiss francs. This created downward pressure on the value of the franc and helped maintain the exchange rate target.
- The SNB's intervention was seen as a way to stabilize the Swiss economy and ensure that Swiss exports remained competitive.
Outcome:
- The intervention lasted for several years, until January 2015, when the SNB unexpectedly removed the minimum exchange rate. At that point, the Swiss franc surged dramatically in value against the euro and other currencies, as the SNB no longer supported the exchange rate target.
This case highlights how central banks can use direct interventions in the FX market to influence their domestic currency's value in order to support economic stability
