Question

Assessment of Central Bank Intervention by the Sports Exports Company

Jim Logan, owner of the Sports Exports Company, is concerned about the value of the British pound over time because his firm receives pounds as payment for footballs exported to the United Kingdom. He recently read that the Bank of England (the central bank of the United Kingdom) is likely to intervene directly in the foreign exchange market by flooding the market with British pounds.

How would the performance of the Sports Exports Company be affected by the Bank of England’s policy of flooding the foreign exchange market with British pounds (assuming that it does not hedge its exchange rate risk)?

Answer 1

The Bank of England's policy of flooding the foreign exchange market with British Pounds will lead to depreciation of Pounds in the foreign exchange market. As the dollar depreciates, the value of currency where the Sports Exports Company operates will appreciate. This appreciation of the home currency of the company with respect to Pounds will reduce the level of net exports of the company because their home currency goods will become expensive which will reduce the level of exports from the nation. As the exports from the nation will reduce the payment received to the company in Pounds will decrease.