Monetary policies are fundamental tools used by governments to regulate the money supply and influence a country’s economy. Through these economic measures, monetary authorities seek to control inflation, promote sustainable economic growth, and stabilize the national currency.

Each country adjusts its policies according to its specific economic conditions, and these decisions have a direct impact on the global foreign exchange market, affecting trade relations and the competitiveness of currencies on the international stage.

In this article, we’ll understand what these monetary policies are, how Asia influences the market, how they affect trade agreements between countries, and more. Follow the content and check out the full explanations provided by expert Victor Arduin, Energy and Macroeconomic Analyst at Hedgepoint. Happy reading!

What are monetary policies?

There are two main situations in which monetary policy is important within a country: controlling inflation and stimulating the economy.

The first occurs when there is a general increase in prices and needs to be controlled.

The second is when the economy is stagnant and needs to be stimulated to grow. In both cases, monetary policy can be used by the central bank to move the dynamics of its economy.

“Therefore, a monetary policy can be in an expansionary or restrictive cycle, with interest rates being the main tool used by central banks to influence the economy in a given period,” says Arduin.

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Expansionary monetary policy

Expansionary monetary policy is aimed at stimulating consumption and moving the economy forward. It is usually used in times of recession or low growth.

“In practice, this means that the central bank will lower interest rates on loans to encourage businesses and consumers to invest more. In addition, banks will also put more money on the market with other financial market instruments to facilitate lending,” Arduin adds.

As a result, these measures will increase consumption in the country and accelerate the stagnant economy. The main risk of this tool is inflation: with more money in circulation, its economic power can decrease in relation to other international currencies.

Restrictive Monetary Policy

This policy is used in times when the economy is suffering from inflation. The goal is to slow down the economy in order to control purchasing power and prevent devaluation. This policy is most often used in emerging and developing countries.

Its actions include raising interest rates and reducing the money supply. In these cases, the central bank makes credit more expensive and discourages consumption to slow inflation. These measures can slow a country’s economic growth, but they are essential to maintaining the organization of the country’s economy in the face of the international market.

“Countries try to control these price dynamics until they reach a specific inflation target. Today, in Brazil and Mexico, that target is 3%. In the United States and Europe, for example, it’s 2%,” the expert adds.

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Monetary policy and the currency market

Since monetary policies control the value of a currency, they also have a direct impact on the currency market. For example, if a country pursues an expansionary policy, its currency may depreciate against another currency (it will take more Brazilian reals to buy one dollar). On the other hand, a depreciated currency may increase exports because it is more attractive.

In the case of a restrictive policy, the appreciation of the currency increases in relation to the other (fewer reais to buy a dollar). But this also means that prices are not attractive for exports.

“Brazil, for example, has an economy that is very import driven, whether it is wheat, oil, diesel, electronics and more. When its exchange rate is more appreciated, the currency favors lower prices for imported products,” says Arduin.

The influence of Asian monetary policies on the foreign exchange market

The monetary policies of Asian countries, especially the larger economies, have a high impact on the global foreign exchange market due to the large participation of these nations in international trade and the movement of commodities. As these policies influence currency values, each adjustment in Asian interest rates alters the monetary competitiveness of other economies.

According to Arduin, “Asia has strong market dynamics. The countries there consume a lot of commodities and export a wide range of products. As it is the most populous continent on the planet, any change in monetary policies will trigger a change in demand for products.”

Countries like Japan, China and India export and import a large number of commodities, such as soybeans, corn and palm oil. When China uses expansionary monetary policies, for example, the yuan loses competitive power and reduces the price of products imported from that country. In this way, nations that have trade agreements with China, such as Brazil, are favored by changes in monetary policies.

Another consequence is the pressure that the expansionary policy puts on countries that compete directly in exports. A weaker currency makes competitors’ products more expensive in comparison.

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According to the expert, Japan is one of the main Asian countries influencing the foreign exchange market. In recent years, the country has maintained a low-growth economy with negative interest rates. But in March 2024, the Central Bank of Japan announced a new monetary policy: interest rates went from -0.1% to 0% and 0.1%. It’s a small change, but one that represents the country’s quest for currency control.

“For the first time in many years, Japan is entering the positive interest rate camp. This has had an impact on the performance of emerging currencies, such as the Brazilian real and the Mexican peso,” adds Arduin.

Because of this unique feature in its monetary policies, Japan has played an important role in the market: investor operations. Due to Japan’s low interest rates, the yen has always been a good option for those who borrowed money in the country at negative interest rates and invested in higher-interest nations. These trades have an influence on the foreign exchange market because they move the flow of capital and yen rates.

“As for the other countries on the Asian continent, the dynamics of monetary policy in the Philippines, Indonesia, Vietnam and India are moving towards a less restrictive scenario. By lowering interest rates, these economies could accelerate growth in 2025 and heat up the global market with greater consumption of commodities,” Arduin concludes.

In short, Asian monetary policies influence the foreign exchange market;

• By the competitiveness of international currencies: Asian currency devaluation can stimulate exports, but it also creates pressure on other exporting economies. This can force them to adjust their own policies to maintain competition in the market.
• Capital flows: changes in interest rates in Asian countries move capital between markets, altering the currency balance.

The appreciation of Asian currencies affects the prices of products imported from these countries, mainly impacting emerging nations such as Brazil.

What role does hedging play in the financial protection of companies exposed to foreign exchange?

Monetary policies influence the world exchange rate and, consequently, affect commodity values. Trade transactions between Brazil and China, for example, are impacted when the Chinese currency is appreciated or devalued.

Hedging helps both countries maintain a fixed exchange rate, regardless of changes in domestic interest rates. This practice reduces the risks of exchange rate fluctuations and increases business predictability.

At Hedgepoint, you can learn more about hedging with a complete course that ranges from beginner to advanced level. Simply access the Hedgepoint HUB platform, log in and subscribe to the portal. As well as lessons, you can also access market reports, calls with experts and more.

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