Determine the exchange rate

When a currency is freely floating, the central bank doesn't have to set monetary policy to alter the external value of the currency unless instructed to by the government. In this circumstance, market forces of supply and demand will determine the exchange rate.

If a country adopts a fixed exchange rate, the central bank will primarily use its interest rate (Bank Rate in the UK) to keep the exchange rate at or close to the fixed exchange rate. In the UK, the Bank of England would increase Bank Rate to attract capital flows into the domestic banking system, thus increasing the demand for the pound. The Bank of England can also buy pound on foreign exchange markets to try to prevent the exchange rate from falling, or sell the pound to try to stop the exchange rate from rising. It can also increase money supply to prevent exchange rate from rising, or reduce the money supply to engineer the opposite effect.