The monetary policies of central banks:

Most Central Banks, at the national level, remain sovereign in the control of their monetary policies (except the European Central Bank located in Frankfurt). The value of one currency in relation to another depends on several factors that will be discussed in this article.

First, the value of one currency relative to another has a significant impact on the external trade balance between two countries.
A country with a weak currency will tend to export its services and products abroad well, facing importers who will benefit from the drop in costs in their own currency. And vice versa, a strong currency will tend to affect the country’s trade balance, as Donald explained, while imports will be cheaper. In April, when political doubts were hanging over Europe before the results of the French presidential elections and the dollar was at relatively high points against the euro (around 1.06), we had reached a point where this strong dollar penalized American exports. It therefore complicated the rebalancing of the trade balance, one of President Trump’s commitments. The manufacturing sector is particularly affected by competition from Mexico or China, for example. By complaining about the strong dollar, Mr. Trump caused an immediate decline against the euro, but this strategy is not sustainable. Its room for manoeuvre is limited. He could appoint supporters of low interest rates to the Fed in the hope of diluting the value of the greenback. But this unprecedented strategy could lead to opposition from Congress, which must confirm the appointments. Another way is to impose an additional cost on foreign products to make them less competitive, through an import tax. But the Trump administration has not clarified its position on the currency. In February, Treasury Secretary Steven Mnuchin praised the virtues of a strong dollar “over the long term”.

One of the main actions of central banks regarding their monetary policies and to influence their key rates. High rates in a certain currency zone are expected to strengthen the local currency against currencies whose local central banks would have introduced lower rates.
Indeed, high rates in a currency zone attract investors, who are then interested in the local currency because it can now be invested at relatively attractive rates of return.
In addition, higher rates may reflect the improvement in the economy in general, such as the various Fed rate hikes in the United States at the end of last year and in early 2017 at 1%. This rate increase was only 25 basis points, which may seem small to the uninitiated but which is ultimately quite significant in terms of improving the American economy.

The central banks all have inflation targets (for example, the European Central Bank targets 2.00% inflation rate over the year) to make the economy generally healthier. To achieve their goals, they can influence their interest rate policies as mentioned above.

Some currencies in the foreign exchange market act as safe havens in periods of uncertainty, such as the Swiss franc, the Japanese yen and the US dollar.
Starting with other asset classes, gold can also be cited as a safe haven, as central banks often possess a large quantity of it.

Some of these central banks may use more extreme means in terms of controlling the exchange rate of their currencies against others.
For example, we can take as an example the Swiss and Czech Central Banks that have previously introduced minimum rates for their currencies. The first at 1.20 against the Euro and the second at 27 against the US dollar.
However, on 15 January 2015, the Swiss National Bank (SNB) abandoned this floor rate and the exchange rate of the Swiss franc rose instantly from 1.20 to 1.08, causing the Swiss franc to partially lose its status as a safe haven. However, investors continue to fall back on the CHF because its volatility is still lower in principle than other currencies.

This phenomenon did not occur when the Czech Central Bank also removed its floor rate against the dollar in March 2017, creating only unusual short-term volatility before the price stabilized again.

To summarize, Central Banks use a multitude of means to make the local economy more efficient. The solutions briefly presented here represent only a sample of these possibilities.

Baptiste LIRZIN


Receivers: EURCHF chart

Receivers: EURCZK chart

Baptiste LIRZIN

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