Q&A: Currency interventions
- 18 March 2011
- From the section Business
The world's biggest economies have got together to intervene in the currency markets for the first time in more 10 years.
What is currency intervention?
It consists of buying or selling on the currency markets, trading from one currency to another.
For example, if you are selling yen you would automatically move into another currency such as the dollar.
Why would governments want to intervene?
A currency which is seen to be too strong is damaging to exporters and their ability to compete in world markets.
This is what has happened to Japan. So it's not surprising that the authorities want to weaken it.
Equally, intervention can help prop up a weak currency - a fall on the foreign exchanges is an inflationary risk as it makes imported goods more expensive.
How does it work?
Governments hold reserves of foreign currencies, usually held in special accounts at their central banks.
Ministers instruct the central banks to buy or sell currencies using these reserves. Britain has about £50 billion of reserves.
Does it always work?
It usually has a short-term impact. Longer-term, the effects are less predictable.
The markets know that governments have limited reserves of currencies and cannot intervene indefinitely.
What exactly is Japan's currency problem?
Even before the earthquake and tsunami, the Japanese yen had been relatively strong against other currencies.
Exporters had been suffering as it was harder to sell their goods outside Japan.
This was hindering Japan's ability to recover from recession and the economy contracted in the final quarter of last year.
Why did the latest disaster make things worse for the Japanese currency?
The yen started rising soon after the earthquake struck as markets anticipated that companies would need to move overseas funds back home.
Major manufacturers need to repair construction facilities so they are likely to shift funds from foreign operations.
By definition this will strengthen the yen as companies switch from holdings of dollars and euros.
This week the yen was the strongest it has been against the dollar since WWII.
Why did the G7 get involved?
The G7 group of leading industrialised nations was approached by the Japanese for help in the currency markets.
The aim was to concentrate as much firepower as possible on the foreign exchange markets.
A conference call for G7 finance ministers, including the UK's George Osborne, and central bank governors took place late on Thursday evening. An intervention strategy was agreed.
A British source said that the Chancellor saw this as a move to help Japan economically.
How did the intervention work in practice?
Starting at midnight UK time, the Japanese central bank moved into the market, selling yen and buying dollars (an estimated $25 billion).
The Bank of England sold yen and bought sterling when the London markets started up.
The Bank won't reveal the size of its transactions. The US and Canadian central banks were ready to move when their markets opened.
When did intervention like this last happen?
In recent years its not been attempted.
In a globalised trading culture, trying to stand against the market is hard to sustain.
Around $1.5 trillion dollars are traded every day on the foreign exchanges.
The last concerted G7 intervention was in 2000 when member governments tried to prop up a weak euro.
So has this yen intervention worked?
The Japanese currency fell in value as the G7 move took effect.
It sends a signal to traders that the rising yen is not a "one way bet" and that Japan's international allies are ready to use their muscle in the markets.
Longer term, it's impossible to say where the yen will go.
The G7 won't confirm or deny whether it will try further intervention.