What Is a Pegged Currency?
A currency peg fixes the exchange rate to another currency or basket. Learn how pegs work and when they break.
Key Takeaways
- A currency peg fixes a country's exchange rate to another currency, usually USD
- Pegs provide exchange rate stability but require large foreign reserves to defend
- When a peg breaks, the devaluation can be sudden and severe
- Gulf states (UAE, Saudi Arabia) peg to USD; Hong Kong has pegged since 1983
What a currency peg is
A currency peg is a monetary policy where a country's central bank sets its currency's exchange rate at a fixed level against another currency or basket, and actively intervenes to maintain that rate. The most common peg target is the US dollar, though some currencies peg to the euro or a trade-weighted basket.
How a peg is maintained
The central bank must stand ready to buy or sell unlimited quantities of its currency at the pegged rate. If market forces push the currency below the peg, the central bank sells foreign reserves and buys its own currency to support the rate. This works as long as the central bank has sufficient reserves. When reserves are depleted, the peg breaks.
Benefits of a peg
For countries with a history of currency instability or high inflation, a credible peg provides a nominal anchor that reduces inflation expectations and encourages trade and investment. The Gulf states peg to USD in part because oil is globally priced in dollars — a dollar peg eliminates FX risk on their primary export revenue.
The risk of peg breaks
When a peg breaks — as Argentina's peg did in 2002, or the UK's ERM peg in 1992 — the adjustment is typically sudden and severe. The currency devalues sharply (often 20-40% overnight). For businesses trading with a pegged-currency country, a peg break represents a sudden, severe change in the economics of that trading relationship.
Implications for UK businesses
If you trade with Gulf states (UAE, Saudi Arabia, Qatar — all USD-pegged), your FX risk with these countries is effectively USD exposure. Monitoring USD/GBP gives you the relevant FX view. If you trade with countries with more fragile pegs, build contingency planning for potential devaluation into your pricing and contract terms.