Of the major central banks, the US Federal Reserve has raised its policy rate by 25 basis points each on sixteen occasions from 1.0 per cent in June 2004 to 5.0 per cent by May 2006. The ECB and Bank of England are hinting at policy rate increases in the coming months.
Under these conditions, certain stylised aspects of exchange market behaviour need to be kept in mind while dealing with monetary and exchange rate management from a medium term perspective. First, the day-to-day exchange rate movements in the short-run in foreign exchange markets have little to do with the so-called ‘fundamentals’ or a country’s capacity to meet its payments obligations, including debt service.