Central bank interventions work... or not?

On 22 September 1985, the central banks of the United States, Japan, West Germany, France and the United Kingdom signed the Plaza Accord, New York City’s famous Plaza Hotel. It was agreed that the dollar would be allowed to decrease relative to the yen and the Deutsche Mark. Five years and ten billion dollars later, the Louvre agreements put an end to the interventions, as the dollar was deemed to have descend to a reasonable.

On 16 September 1992, American financier George Soros became ‘The Man Who Broke the Bank of England’, after taking advantage of the weaknesses of the European monetary system to carry out a speculative attack against the pound sterling. To defend its currency, the Bank of England had to intervene massively to support it. But with only limited reserves at its disposal, the BoE was forced to give in and devalue the pound. The amount committed by George Soros’ fund alone is estimated at £10 billion sold. The British currency lost 15% of its value.

On 15 January 2015, after vigorously defending the floor rate of 1.2000 against the euro, the Swiss National Bank had to admit defeat and announce the end of interventions to defend the franc. The franc soared and the exchange rate went from 1.2000 to 0.8500 for one euro.

Finally, last Friday was another one for the (financial) books. With the dollar at its highest level against the yen in more than 30 years and worth almost ¥152 to the dollar, the Bank of Japan decided to intervene massively. Between 4:30 PM and 6:00 PM, the greenback fell back to ¥146 as a result of the dollar sell-off. This intervention, estimated at $30 billion by the Financial Times and $36.8 billion by Japanese broker Central Tanshi, is the largest ever in a single day. On Monday morning, the market was still experiencing a lot of turbulence but the dollar was stabilising at around ¥148. As of 22 September, Japan had already intervened to the tune of $21 billion to halt the fall of its currency, pushing the exchange rate from ¥146 to ¥140 to the dollar. The yield spread between the US currency and the Japanese currency is set to widen further, meaning the BOJ is facing an uphill climb. The battle between the Japanese central bank and the market is just beginning.

The tally so far is one for the central banks in 1985 and two for the markets in 1992 and 2015. Who will win in 2022? One thing is clear. In the face of abundant market liquidity, it is unlikely a single central bank will be able to win the battle.

The Japanese intervention also had a significant impact on other currencies against the dollar. The greenback fell from 1.0150 to 0.9980 against the Swiss franc on Friday. The euro recovered two cents from 0.9710 to 0.9899 on Monday morning. The market will now be turning its attention to the European Central Bank’s monetary policy meeting tomorrow. According to ECB president Christine Lagarde, the Bank’s priority is not to let the rise in prices in the eurozone, which reached an annualised 9.9% in September, compared to 9% previously, ‘become entrenched’. Analysts are expecting a further 0.75% rate hike that would take deposit rate to 1.50% and the marginal lending facility rate to 2.25%. This increase, if it takes place, will probably support the euro for a few days. On 2 November, 6 days later, the Fed will announce its decision and it should match the ECB with a hike of the same magnitude and thus keep the yield spread steady.

Embroiled in political problems and Liz Truss’ disastrous tenure at Downing Street, the pound only modestly benefited from events on Friday. However, the appointment of market favourite Rishi Sunak as Prime Minister on Monday has brought a measure of calm to the British currency which is approaching 1.1500 against the dollar. But the new PM has a daunting task ahead, as he himself has said, in a country where the crisis is beginning to be felt severely and where inflation is breaking records at 10.1%. This is the highest rate in 40 years and also the highest of the G7 countries. Without price stability, household budgets are increasing and work becoming less and less secure.

In China – one week late and after the expected re-election of Xi Jinping on Sunday – growth figures are finally available. Gross domestic product grew by 3.9% on an annual basis against an expected 3.3%. Industrial production rose by 6.3% in September year-on-year, following a 4.2% increase previously. The PBOC has relaxed the rules that allow companies to borrow from abroad. It raised the so-called macro-prudential parameter for cross-border borrowing from 1 to 1.25. By doing so, it allows companies to increase their financing abroad. The decision had an immediate impact on the Chinese currency, which fell sharply to its lowest level since 2008. It traded at 7.3749 yuan to the dollar yesterday morning before it recovered and fell back below 7.3000 today.