What role do central banks play in the foreign exchange market?

Central banks play a crucial role in the foreign exchange market primarily by influencing currency values through various monetary policy tools and market interventions. Their policies can include adjustments to interest rates, which affect inflation and economic growth, thereby impacting the value of the national currency. For example, if a central bank raises interest rates, it often strengthens the currency as it attracts foreign capital investments seeking higher returns.

Moreover, central banks may intervene directly in the foreign exchange markets by buying or selling their own currency to stabilize or influence its value against other currencies. Such interventions can be necessary during periods of excessive volatility or when a currency is perceived to be misaligned with economic fundamentals.

In contrast, monitoring currency trends does not actively affect currency value, nor do central banks set daily exchange rates as a fixed price. Stock market valuations, while influenced by economic conditions, are not the direct responsibility of central banks. Thus, the assertion that they influence currency value through monetary policy and interventions accurately captures their essential functions within the foreign exchange market.