Central Bank, Main Player in the Forex Market
In the forex market central banks are masterminds or major players who have the ability to ‘manipulate’ the price of a currency. But don’t get me wrong first. The purpose of price manipulation here is not as bad or as bad as you think. Unlike retail traders who have wishful thinking if they have the ability to move prices with the aim of gaining profits for themselves.
Central banks will not do that. They will not seek profits from manipulating prices from currency exchange rates. They try to carry out the mandate given by their respective governments with good intentions and objectives and certainly not harmful.
One of the central bank’s tasks is from the government
One of the tasks of the central bank of the government is to intervene in the forex market. The goal is to stabilize the price or exchange rate of their currencies so that they are not too low or not too high.
Central banks will usually intervene in the forex market with the intention of to:
- offset the impact of trade imbalances.
- increase liquidity and reduce the volatility of currency values during certain conditions such as the financial crisis.
- push the value of a higher or lower currency stabilizes in the eyes of the central bank.
Central banks have a heavy duty and responsibility to maintain currency exchange rates continuously, the Central Banks monitor their currencies. In the trade sector, the surplus will give a boost to the value of the currency to be higher.
The central bank will intervene in the market by injecting more domestic currency into the market by buying foreign currency. This is done to offset the impulse from the impact of trade flows or other factors that make the value of the domestic currency higher.
You must have heard the central bank “prints money”. The action was carried out with the aim of increasing the supply of domestic currency in the amount desired by the central bank. In addition, this method also builds the central bank’s foreign exchange reserves.
How to reduce pressure from deficits that push the value of the domestic currency lower?
The central bank will use its foreign exchange reserves to buy domestic currency so that there will be an increase in demand for the currency. This action is taken to reduce the supply of domestic currency in the market, and increase demand for the currency so that the value will return to stability. But this method also reduces foreign exchange reserves from the central bank itself.
Impact of Central Bank Interventions
It is very important to note and underline that all actions taken by the central bank are not without risks and consequences. Injecting too much domestic currency into the market to make the price of the currency go down. As well as increasing the money supply can cause the risk of inflation to be greater.
Conversely, if the central bank buys too much domestic currency from the market to bring the value of the currency higher. This will reduce the amount of money in circulation and can cause deflation.
Central bank intervention
Given this, the central bank must think carefully about what decisions are made. So it is not every time the central bank is able to intervene in the market according to their own will. They need to weigh the bad effects of the intervention they will do.
Here’s the point of this point. If the central bank wants to try to reduce the money supply by using foreign exchange reserves of their foreign currency to buy domestic currency. This method will succeed in reducing the money in circulation. But the bad will also push the currency back up. It was useless for the intervention of the central bank and only circling it alone. But there are other ways if the central bank wants to reduce the value of the currency but not by increasing the money supply.
By injecting money into the domestic and international markets by means of a reverse. Then it will trigger a risk of deflation because of the declining supply of money. That is the problem if a country finds too little domestic currency circulating in the market.