What Is a Key Currency?
A key currency refers to a currency which is stable, does not fluctuate much, and provides the foundation for exchange rates for international transactions. Because of their global use, key currencies tend to set the value of other currencies. Also, these currencies tend to have a stable valuation over time. A key currency usually comes from a country that is financially strong, economically stable and developed, and one that is involved in the global market.
Nevertheless, key currency rates do fluctuate daily, and updated key currency rates can appear in financial institutions and financial reporting outlets.
- Key currencies are stable, globally used currencies in international trade and commerce.
- Other countries may peg their own currency to a key currency, or a basket of such monies, and they are often kept as reserves by international central banks.
- The seven key currencies today are the U.S. dollar, the Euro, the British pound, the Japanese yen, the Canadian dollar, the Swiss franc, and the Mexican peso—although other contenders, such as the Chinese yuan, also exist.
Understanding Key Currencies
Key currencies form the reference value for international commerce transactions and as an exchange rate in the foreign exchange (forex) marketplace. An exchange rate is the price of a nation’s currency relative to another country's currency, and it includes the domestic currency and the foreign currency. International commerce is trade between companies in different countries or trade between different countries.
National central banks hold quantities of key currencies as reserve currencies. Reserve currency helps these nations support investments, complete international business transactions, and pay international debt obligations. These banks may also hold key currency to influence their domestic exchange rate. A large percentage of commodities, such as gold and oil, are priced in the key and reserve currency, causing other countries to hold this currency to pay for these goods. However, a currency used as a reserve currency may not be considered a key currency.
As a monetary practice, countries with weaker economies will align their exchange rates with a dominant trading partner. The central bank of some developing nations may fix their exchange rate to a key currency. Known as currency pegging, this practice has the effect of limiting monetary policy flexibility but can increase confidence in a country's economy.
By fixing their own currency exchange rates to key currency rates, central banks in some developing nations hope to make their own economy more stable and make international transactions easier.
Examples of Key Currencies
While the term key currency is not precisely defined by any quantitative threshold for use or reference as a benchmark, some key currency examples can be identified based on their characteristics. These include:
- The U.S. dollar (USD) has been the leading key currency in the global economy for over 70 years. In this role, the U.S. dollar is used to measure the value of other country’s currencies. Many other nations will invest in the U.S. dollar for its global value and stability. In a positive feedback cycle, the U.S. dollar is the base currency for other currencies, and other countries invest in it as a haven, which has the end result of strengthening the dollar even more. The result is that the USD constitutes just under 60% of global foreign exchange reserve holdings. However, the dollar's status has begun to erode in recent years as the USD has lost popularity as a global reserve currency.
- The Euro (EUR) is the official currency for the European Union (EU) and is the second most significant international currency after the U.S. dollar. As of the first quarter 2021, the Euro makes up about 20% of official reserve currency claims held by central banks around the world.
- The British pound (GBP), or British pound sterling, is the official currency of the United Kingdom, the British Overseas Territories of South Georgia, the South Sandwich Islands and British Antarctic Territory, and the U.K. crown dependencies.
- The Japanese Yen (JPY) is widely used as a reserve currency and frequently paired on the foreign exchange market.
- The Canadian dollar (CAD) is a benchmark currency and was the first currency allowed to float in 1950.
- The Swiss franc (CHF), known for its neutrality—the country's banks have had a policy of secrecy dating back to the Middle Ages—is an exceptionally strong and stable currency.
- The Mexican peso (MXN) is the fifteenth most traded currency in the world and the most traded in Latin America.