A currency peg is a policy that ties the value of one country's money to another currency, usually a larger and more stable one such as the United States dollar, and commits the authorities to keeping it there. Instead of letting the exchange rate float freely on the open market, a government or central bank promises to hold it at a fixed level, or within a narrow band, and intervenes to defend that promise. Understanding how a currency peg works explains why some currencies barely move for decades, and why others snap suddenly when the peg breaks.

Fixed versus floating

Most major currencies, including the dollar, the euro, the pound and the yen, float: their exchange rates are set by supply and demand in global markets and move every second. A pegged currency does the opposite. The authorities pick a target rate against an anchor currency and then do whatever it takes to keep the market rate near it.

The appeal is stability. A country that trades heavily with the United States, or that has struggled with high inflation, can borrow the credibility of a stronger currency by pinning its own to it. Businesses can price and plan without worrying that the exchange rate will lurch. The cost is that the country largely gives up an independent monetary policy, a trade-off that connects to how a central bank sets interest rates, explained in our guide on how the Federal Reserve works.

How the defense actually works

To hold a peg, the central bank has to be willing to buy and sell its own currency in unlimited amounts at the target. The clearest working example is Hong Kong. The Linked Exchange Rate System has tied the Hong Kong dollar to the United States dollar since October 17, 1983, and the Hong Kong Monetary Authority says it "ensures that the Hong Kong dollar exchange rate remains stable within a band of HK$7.75-7.85 to one US dollar."

The mechanism is a set of convertibility undertakings. At the strong side, 7.75 Hong Kong dollars per US dollar, the authority sells Hong Kong dollars and buys US dollars; at the weak side, 7.85, it does the reverse, buying Hong Kong dollars and selling US dollars from its reserves. Buying up the local currency drains cash from the banking system and pushes local interest rates up, which makes holding Hong Kong dollars more attractive and pulls the rate back toward the middle. In mid-October 2026 the Hong Kong dollar was trading around 7.8475, near the weak edge of the band, the kind of level that can trigger intervention, according to Business Recorder.

What a peg demands

Defending a peg is not free, and it rests on two things: reserves and interest rates.

• Foreign-exchange reserves. To sell dollars and buy its own currency, a central bank needs a stockpile of hard currency. When traders bet against a peg, the bank burns through reserves defending it, and a peg is only as credible as the reserves behind it.
• Interest rates. Because the bank must set rates to defend the peg rather than to suit its own economy, it imports the monetary policy of the anchor country. If the anchor raises rates, the pegged country often has to follow, even if its own economy would prefer the opposite.

That second point is the hidden price of a peg. It can force a country to run tight policy during a downturn, or loose policy during an upswing, simply to keep the exchange rate in place.

When pegs break

Pegs hold until defending them costs more than abandoning them, and then they can break fast. Britain was forced out of the European Exchange Rate Mechanism in September 1992 after spending heavily and raising rates to defend the pound, to no avail. Argentina abandoned its one-to-one peg to the dollar in early 2002 amid a deep crisis. And in January 2015 the Swiss National Bank abruptly scrapped the cap it had set on the franc against the euro, and the franc moved sharply higher within minutes.

Each case was different, but the pattern rhymes: a fixed rate that markets no longer believe becomes a one-way bet for speculators, reserves drain, and the authorities eventually let go. The lesson is not that pegs always fail, Hong Kong's has held for more than four decades, but that a peg is a promise that has to be continuously funded and defended.

How to read a peg

For a reader watching a pegged currency, the questions are consistent: how large are the central bank's reserves, where is the rate sitting within its band, and is the anchor country's monetary policy pulling in a direction that strains the peg. A currency parked quietly at its fixed rate tells you the defense is working; one pinned against the edge of its band, as the Hong Kong dollar was in October 2026, tells you the authorities may soon have to act.

It also helps to know what the peg is anchored to, because a currency pinned to the dollar effectively rises and falls against everything else as the dollar does, which can matter more for trade and travel than the peg itself. None of this is advice on trading any currency, and currency speculation is risky and not the point here. The point is mechanical: a peg is a central bank standing behind a fixed exchange rate with its reserves and its interest-rate policy, and it lasts exactly as long as that commitment stays credible.