Pegged Currencies: How Fixed Exchange Rates Are Defended

A pegged currency is usually explained as a rate that a government has decided to hold at a chosen level. That description is not wrong, but it leaves out the part that determines whether the rate actually holds.

An exchange rate cannot be set by announcement. It holds because someone is willing to transact at the stated level in whatever size is asked, and can keep doing so.

This page is about that machinery: what the commitment consists of, what it costs, how the main regime types differ, and what a defended rate looks like from the outside.

What a Currency Peg Actually Is

A peg is a commitment by a monetary authority to keep its currency at a stated value against an anchor, most often another currency. What distinguishes it from a preference or a target is that the authority is obliged to act on it.

The obligation is what turns a stated number into a price. A rate that no one is required to defend is a forecast, and the market prices it accordingly.

Hong Kong is the clearest documented example of the machinery. The Hong Kong Monetary Authority states that its Linked Exchange Rate System has been implemented since 17 October 1983, and that through a Currency Board system it keeps the Hong Kong dollar within a band of HK$7.75 to HK$7.85 to one US dollar.

Two details in that sentence do the work. There is a band with two edges rather than a single number, and there is a Currency Board arrangement standing behind it rather than a discretionary promise.

The distinction between a peg and the terms used to describe its failure is covered separately. Our page on devaluation and depreciation explains which word applies to which event, and how to establish the regime a given currency is under.

How a Peg Is Defended in Practice

Defending a peg means being the counterparty nobody else wants to be. When the market is selling the currency, the authority buys it and pays in foreign reserves. When the market is buying, it sells its own currency and accumulates reserves.

The two directions are not symmetric in difficulty, which is the most useful thing to understand about pegs.

Defending against strength is comparatively easy. A central bank can create its own currency without limit, so it can always supply more of it and take in foreign assets in exchange.

Defending against weakness is bounded. It requires selling foreign reserves, and reserves are finite. A regime under pressure to weaken is spending a stock that can run out, which is why weak-side pressure is the direction that ends regimes.

The formal language used by the issuing authorities makes the obligation explicit. The European Central Bank publishes what it calls compulsory intervention rates for currencies participating in the exchange rate mechanism, which are the levels at which intervention is not discretionary.

That word is the difference between a peg and a preference. An authority that intervenes when it chooses is managing a float; an authority that is obliged to intervene at a published level is defending a peg.

Hard Pegs, Currency Boards and Bands

These arrangements are frequently presented as points on a single scale from fixed to floating. They are better understood as different answers to one question: how far may the rate travel before the authority must act?

The table sets them out by that question rather than by rigidity, because permitted travel is what a reader watching a price observes.

The band case is where published figures are most instructive, because the edges are stated rather than inferred.

For the Danish krone, the European Central Bank publishes a central rate of 7.46038 to one euro, an upper rate of 7.62824 and a lower rate of 7.29252. It also records that Denmark has participated in the mechanism since 4 January 1999.

Those three figures are worth reading as a set. The upper and lower rates each sit exactly 2.25 per cent from the central rate, so the arrangement is a defended corridor of a specific published width rather than an approximate level.

Most explanations of this arrangement quote only a single approximate number near the central rate. That version omits the two rates at which action is actually obliged, which are the only levels where the regime does anything.

Where a band width could not be confirmed at the issuing authority, none is published here. Several currencies described elsewhere as pegged operate under arrangements whose current parameters are not straightforward to verify at source, and an unverified width is worse than no width.

Reserves, Interest Rates and the Cost of Defence

A defended rate is not free. It is paid for in two currencies: foreign reserves, and the freedom to set interest rates for domestic conditions.

The reserve cost is the visible one. Holding the weak edge means selling foreign assets, and the market can observe the stock shrinking, which tends to invite more pressure rather than less.

The policy cost is less visible and often more binding. If the currency is under pressure to weaken, raising interest rates makes holding it more attractive and relieves that pressure.

But interest rates set to defend an exchange rate are not available to address domestic conditions. An economy that needs lower rates may find itself with higher ones, purely because the rate must be held.

This is the trade the regime makes. Stability in the exchange rate is bought with the loss of an independent interest rate policy, and that loss is what usually becomes intolerable first.

Our page on central bank policy covers how policy stance is read from statements and decisions.

What a Pegged Pair Looks Like to Trade

A pegged pair does not behave like a floating one, and the differences are practical.

The first is range. While the regime holds, daily movement is compressed by design, and strategies that depend on a pair travelling a normal distance simply do not find that distance.

The second is cost. When price movement is small, the financing charged or paid for holding a position overnight becomes a larger share of the outcome than the price itself.

That inverts the usual relationship. Our page on interest rate differentials explains how those charges accrue, and why they can dominate a position whose price barely moves.

The third is behaviour at the edges. In a banded regime the rate tends to spend time near an edge and then retreat, which produces a chart that looks like a range but is not one in the usual sense.

An ordinary range is made of buyers and sellers who may change their minds. A defended edge is made of an obligation, until the obligation is withdrawn.

Pegged and heavily managed currencies also tend to sit in the thinner end of the market. Our page on exotic currency pairs covers what that means for spreads and for the gap between a quoted price and an achievable one.

When a Peg Breaks: the Swiss Franc Case

The Swiss case is the clearest documented instance of a defended rate ending, and it is documented by the authority that ran it.

On 6 September 2011 the Swiss National Bank announced that it was setting a minimum exchange rate of CHF 1.20 per euro. The commitment was to enforce that floor without a stated limit on the quantity of foreign currency it would buy.

The regime then held for more than three years, during which the pair spent long stretches close to the floor with very little daily movement.

On 15 January 2015 the Swiss National Bank announced that it was discontinuing the minimum exchange rate, and at the same time lowered its interest rate to minus 0.75 per cent.

The two halves of that announcement belong together. The floor was released and the policy rate was pushed further negative in the same decision, which indicates the defence had become expensive enough that the alternative tool was preferred.

What followed is the part that matters for anyone holding a position. Years of suppressed adjustment arrived in a single session, and a pair that had been among the quietest in the market became one of the most violent.

Positions did not simply lose more than expected. Orders resting inside the move were dealt with at whatever prices existed, which in a move of that speed can be far from where they were placed. A stop is a request to transact and not a guarantee of a level, a distinction set out on our page about gapping and slippage.

Why Low Volatility Is Not Low Risk

This is the inference the previous section overturns, and it is worth stating on its own because it is where pegged pairs mislead most reliably.

Volatility measures are backward looking. They summarise how much a price moved over a past window, and on a defended pair that window records the regime working.

The number produced is accurate and the conclusion drawn from it is wrong. A pegged pair reports low historical volatility precisely because an authority spent the period preventing movement.

The measurement therefore describes the strength of the defence, not the exposure of the position. Those are different quantities, and on a floating pair they happen to coincide closely enough that the distinction rarely matters.

On a defended pair they come apart completely. Risk is not spread across ordinary sessions; it is concentrated almost entirely in the event that ends the regime, and that event is absent from every observation used to compute the measure.

The practical consequence is about sizing rather than prediction. Any method that sets position size from recent movement will size a pegged pair as though it were quiet, which is the opposite of what its risk profile warrants.

Who This Page Is Not For

Nothing here identifies a peg that is likely to break, and no page can. The authorities that run these regimes do not announce their intentions in advance, and the Swiss case ended without warning to the market.

If the question is which pegged currency will be repriced next, this page treats that as unanswerable rather than merely difficult.

It is also not a list of every pegged currency with its level. Several figures in wide circulation could not be confirmed at an issuing authority, and are therefore absent rather than repeated.

What the page is for is understanding the machinery: what the commitment consists of, what constrains it, and why a quiet chart on a defended pair is evidence about the regime rather than about the risk.

Frequently Asked Questions