Media Briefings

Words May Mean That Interest Rates Don’t Need To Rise To Prop Up Weak Currencies

  • Published Date: July 2008

Words as well as deeds can be effective for central banks trying to influence the
strength of their currency. That is the conclusion of new research by Marcel
Fratzscher, published in the July 2008 issue of The Economic Journal. The report
finds that up to three quarters of ‘interventions’ in currency markets are successful,
with four out of every five interventions acting to stabilise exchange rates.
This may mean that the Bank of England won’t have to raise interest rates if it wants
to support the pound. Because a weak pound raises the price of imports, a falling
pound can contribute to rising inflation. In the past, the Bank might have felt the need
to raise interest rates to stop the pound weakening and increasing the (already
above target) rate of inflation.
But now central banks the world over are increasingly using words to try to prop up
their currencies. Recently the chairman of the US Federal Reserve, Ben Bernanke,
spoke out against a further weakening of the dollar even though he has slashed
interest rates to 2% following the sub-prime mortgage crisis.
Many central banks have stopped actually buying and selling currencies to influence
their value. US and European authorities have not intervened in foreign exchange
markets since 1995 (with two brief exceptions in 1998 and 2000). Instead, they have
opted to use communication as their primary policy instrument to influence
exchange rates.
While previous research has found evidence that communication and actual
interventions may be effective in the short run (for example, on the days that they
occur), this report produces the first evidence that simply talking about how strong
the monetary authorities would like the currency to be can be effective in the medium
term too.
The report looks at ‘events’ of the Federal Reserve, the European Central Bank and
the Bank of Japan intervening – both directly and with words – in foreign exchange
markets since 1990.
It finds that both communication and actual intervention events were successful and
moved the exchange rate in the desired direction for five days after the intervention
in 65-77% of cases. This effect shows a similar rate of success for up to 40 days
after the event – so interventions work in the medium term as well as the short term.
This is important as short-term fluctuations in exchange rates are unlikely to have a
lasting effect on inflation. It is the long-term level of the exchange rate that
is important.
And in more than 80% of cases, the volatility of exchange rate fluctuations receded
after an event. This is good news for businesses, as a variable exchange rate makes
it harder to plan for the future.
While both words and actually buying and selling currencies can be important in
influencing the value of an exchange rate, words are more effective in times of
market uncertainty. This may be because the words of central banks act to coordinate
currency traders, so that they all have similar beliefs about the future
strength of a currency.
Notes for editors: ‘Oral Interventions versus Actual Interventions in FX Markets –
An Event-study Approach’ by Marcel Fratzscher is published in the July 2008 issue
of The Economic Journal.
Marcel Fratzscher is at the European Central Bank.
For further information: contact Marcel Fratzscher on +49 69 1344 6871 (email:; or Romesh Vaitilingam on 07768 661095 (email: