How do central banks intervene in currency markets?

Central banks intervene in currency markets to control exchange rate volatility, stabilize the economy, and support export-import balance. They do this by buying or selling foreign currency, adjusting interest rates, or giving clear signals through policy statements. These actions directly impact the value of a country’s currency in the forex market.

Why do central banks intervene in the forex market?

Currencies can fluctuate rapidly due to global events, interest rate changes, or speculation. Central banks step in when their domestic currency becomes too strong or too weak, which can hurt exports or trigger inflation. Their goal is to ensure a stable and competitive exchange rate.

How do they intervene?

1. Direct Intervention: The central bank buys or sells its own currency against foreign currencies to adjust supply and demand. For example, if the INR is falling sharply, RBI may sell USD and buy INR to support the rupee.

2. Indirect Intervention: They may change interest rates or use monetary policy tools that affect currency value. Higher interest rates attract foreign investors, increasing demand for the local currency.

3. Verbal Intervention: Sometimes, just a strong statement or hint from central bank officials can influence market sentiment and calm volatility without any actual action.

What is a currency peg or band?

Some countries keep their currency fixed or within a certain range against another currency (like the US dollar). To maintain this, the central bank actively intervenes whenever the currency crosses limits. This method is used to bring predictability to exchange rates.

For example, the Chinese Yuan has been managed against the USD to support export competitiveness.

Do these interventions always work?

Not always. Market forces are strong and often global. If the central bank doesn't have enough reserves or credibility, the intervention may fail. But even then, it can help reduce extreme volatility in the short term and buy time for economic adjustment.

Central banks play a key role in guiding currency values and calming sudden movements. Whether it's through buying/selling dollars, changing interest rates, or sending signals to the market — their actions matter a lot. Traders closely follow every central bank move to make quick decisions in forex trading.