On EM FX interventions and 'sterilized' vs. 'unsterilized' impacts
I've been trying to get my head around how central bank interventions in EM FX markets actually translate to domestic economic effects, specifically the difference between sterilized and unsterilized interventions. My understanding is that sterilized interventions aim to keep the domestic money supply unchanged, thus theoretically limiting inflation, but I'm struggling with how effective this truly is in practice, especially with persistent capital flows. Are we just talking about the theoretical ideal, or do experienced EM traders really see a significant divergence in market reaction and subsequent economic data between the two approaches, beyond the immediate FX impact? I'm trying to refine my macro overlay for $ZAR and $BRL, and this feels like a missing piece.
You're right to focus on the sterilization aspect. While the intent is to neutralize the domestic money supply impact, the effectiveness often hinges on the depth and liquidity of the domestic bond market to absorb the offsetting operations. Also, even 'sterilized' interventions can signal policy intent, which might influence market expectations and capital flows differently than a purely unsterilized approach.