Central Banks

Central banks are key players on Forex market. Taking an active part in financial transactions they aim not at profiting but at adjusting and maintaining exchange rate stability which steers the growth path of national economies.

In order to keep the required exchange rate to prevent serious economic disturbances central banks carry out a massive buying or selling of a currency. Any country which is involved in the global economy is very sensitive to the increase or the decrease of their currency rate against the dollar, the euro or the yen which can lead to economic instability. Thus, central banks regulate the stability of a national currency by changing interest rates. There are three major types of interest rates.

Discount rate is used by central banks to credit commercial banks. Higher the rate, higher is the interest taken in it by foreign investors.

Repo rate is put into practice when central banks perform transactions with commercial banks or other accredited establishments to buy or to monitor government treasury bonds. In such a way central banks actualize the governing of loan capitals value.

Lombard rate is used by central banks when loaning commercial banks secured on real estate and gold values.

The changes occurring in these three types of interest rates exert an impact on the market in the following way. Rates reduction enforces business activity but causes high inflation rates which lead to depreciation of a national currency. Increase in rates proves to influence currency strengthening.

By changing interest rates central banks affect foreign exchange implicitly. An explicit influence is in intervention in order to adjust fluctuations of a national currency. The interference also reveals itself in regulation of the money supply to combat potentially high inflation rates. The regulation is realized through changes in interest rates. In order to decrease the amount of money that chases goods and services central banks tend to adjust interest rates. The intervention may take place for the stability restoration as well as for the protection of a particular price level, for the reduction of a currency movement speed or when a trend needs a change in direction. Central banks can use their lever of interest rates to encourage or discourage investment and affect employment levels in the economy.

As a major purpose of central banks on Forex is stabilization of their national currencies, it can be achieved by purchasing when the rate is low and selling when the existing rates are too high. However, to apply such a method is effective for the countries with unstable currency policy while for the most respected ones it is enough to provide expectations in order to make the currency stable.

The largest central banks influencing foreign exchange are US Federal Reserve System, Deutsche Bundesbank, Bank of England.

Frequently central banks close their transactions indirectly through one or several commercial banks disguising their activities. Central banks of developed countries can collaborate in order to achieve their common goals.