In FX casino, don't bet against the central banks

By Jamie McGeever - Analysis

LONDON (Reuters) - The global foreign exchanges may now be a $3.2 trillion-a-day behemoth but one maxim still holds true: ignore concerted central bank intervention at your peril.

While it may not be imminent, traders are probably on their highest alert for an international move to support a currency since U.S., euro zone and Japanese monetary authorities rallied to the euro's defense in September 2000.

As the dollar plumbed a record low of $1.6038 per euro last week and threatened a new round of food and fuel price rises, calls grew for action to shore up the greenback and Federal Reserve Chairman Ben Bernanke pointedly left the door open to such a move if needed.

And even though the physical amount of foreign currency reserves Group of Seven central banks have at their disposal is tiny relative to FX market volumes, analysts insist coordinated intervention remains a potent weapon in policymakers' arsenal.

"If the currency market is a casino, the central banks are the house," said Neil MacKinnon, chief economist at ECU Group, a London-based hedge fund.

"Although they don't have the firepower to match the daily trading volumes, all it takes is for them to intervene. It doesn't really matter what the size is," MacKinnon said.

As every gambler knows, you don't often bet against the house and come up trumps. The message of the most influential central bankers saying 'enough is enough' is a powerful one, especially if timed right and supported by the broad tilt of relative monetary policies.

The history of concerted FX intervention with the U.S. Treasury on board supports that, especially given that the amount of hard cash spent in these forays is typically modest.

The September 22, 2000, intervention to buy euros was critically reinforced by the European Central Bank and euro zone national central banks over the next couple of months.

Even though the fledgling currency fell back briefly to a record low of $0.8252 on October 26 that year -- a decline of some 30 percent from its $1.1747 debut in January 1999 -- it then embarked on a steady upswing over the following eight years, culminating in last week's record high.

Between April 1994 and August 1995, U.S. authorities regularly intervened with Japanese and European central banks to buy the dollar, which had sunk to a record low of 1.3455 German marks in March 1995 and a post World War Two low against Japan's yen of 79.70 yen a month later.

By August 1998 the dollar was trading above 145 yen and then hit record highs against the mark's replacement, the euro, by October 2000.

Dollar weakness is again the problem. It fell to a record low against the euro last week beyond $1.60 as concern over embattled U.S. mortgage giants Fannie Mae (FNM.N) and Freddie Mac (FRE.N) deepened already entrenched worries about the broader U.S. financial system and economy.

The last thing global policymakers want is for dollar weakness to morph into a run on the currency, a development that would only intensify fears about the value of U.S. assets and aggravate the fuel and food price inflation that is preventing central banks from cutting interest rates to ease the crisis.

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