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Five things to know about the European Central Bank

The European Central bank, or the ECB is the main central bank for the 19 European Union countries which have adopted the euro as their official currency. Unlike many other central banks, the EU sets its monetary policy that concerns the 19 EU countries. Therefore, in some ways, the ECB acts differently compared to other big central banks in the G7.

The actions taken by the ECB directly impact the exchange rate of the euro. The ECB came into existence in 1998, June 1st. This was after a decision was taken to create a single monetary policy mechanism. A few months later, on January 1st 1999, the euro currency was formally launched.

Germany was one of the founding members for the euro. Besides Germany, France, Spain, Portugal, the Netherlands, Belgium, Luxembourg, Italy, Ireland, Finland and Austria were the first members to get on board to use the euro as their official currency.

Over the years, the remaining countries from the EU adopted the euro, making it now a 19 member state strong common currency.

The euro is the second largest liquid currency after the United States dollar. Here are five things to know about the European Central bank.

1. What is the ECB’s monetary policy composed of?

The primary objective of the European Central bank is to maintain price stability. This is done by the ECB targeting the inflation rate at or close to 2% in the medium term. Inflation in the Eurozone is referred to as the Harmonized Index of Consumer Prices or HICP.

The ECB oversees the short term interest rates and thus influences the economic developments for its member nations. Monetary policy decisions are taken at the monetary policy meeting which is held every six weeks.

2. What interest rates does the ECB target

There are three types of rates that the ECB influences. These are:

  • Rates on the main refinancing operations: Banks borrow liquidity from the Eurosystem against collateral on a weekly basis, at a pre-determined interest rate (Interest rate banks pay to borrow. (Collateralized). This is also referred to as the Refi Rate
  • Rate on the deposit facility: Banks make overnight deposits with the Eurosystem at a (pre-set) rate lower than the main refinancing rate. The rate on deposit facility is always lower than main refinancing rate.
  • Rate on the marginal lending facility: The overnight credit to banks from the Eurozone at an interest rate (also pre-set) above the main refinancing rate. (Not collateralized, hence higher than refi rate). This is also referred to as the marginal lending rate.

3. Who are the members of the ECB?

The members of the ECB who influence monetary policy are called as the Governing Council. The governing council members are made of six members of the ECB’s executive board and governors of the 19-euro area member nations.

The President of the ECB serves an eight-year term and is not renewable. The president of the ECB is chosen by a vote from the European council. The president of the European Commission appoints the president of the ECB. The current president of the ECB is Christine Lagarde, who formerly served as the Finance Minister of France and then later on headed to become the IMF chief before taking on the current role.

4. The ECB’s monetary policy tools

The central bank uses various tools in its monetary policy. This includes influencing the various interest rates as mentioned earlier. Besides interest rates, the central bank also uses quantitative easing to inject liquidity into the markets.

This is known as the ECB’s Asset purchase program or the APP. The ECB’s QE involves buying investment grade sovereign and corporate bonds in a bid to lower yields and also to influence inflation indirectly The ECB’s QE began after the 2008 global financial crisis.

5. The ECB Meeting and influence on the euro

As mentioned earlier, the ECB meets six times a week. Monetary policy decisions such as interest rate and QE decisions are taken at this meeting. Following the meeting, the ECB president holds a press conference from its headquarters in Frankfurt, Germany.

Although the ECB maintains that it does not influence the euro’s exchange rate, past history shows that the euro is known to be jawboned whenever it rises too much against the US dollar. Speeches from the ECB members (not just the ECB president) are closely watched as they directly influence the euro’s exchange rate.

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