ECB and Its Mandate
InvestingOnline.com
25/08/2018, 13:27The ECB (European Central Bank) is the second most important central bank in the world, setting the monetary policy on the Euro. As the common currency for nineteen European states, the Euro represents over five hundred million people and is the second most traded currency on the FX dashboard after the USD.
As a central bank, the ECB watches over the economic evolution in the Euro area and adjusts the interest rate on the common currency accordingly. Of all the central banks in the world, it has the most challenging task because the nations part of the Eurozone have different economies.
For instance, the Euro is the common currency for Germans as well as Greeks, Italians as well as French people, making it difficult for a central bank to find a one size fits all solution for its monetary policy. Yet, it its short existence, the ECB did a great job in keeping the Eurozone together and making sure the Euro is here to stay.
European Central Bank’s Mandate
The ECB has a mandate that focuses on price stability. Contrary to many people’s belief, price stability refers to inflation, not to the actual FX market standing still.
Inflation shows the changes in the prices of goods and services over a period. Excessive inflation isn’t good for economic growth. However, there is a consensus among economists telling that moderate inflation creates economic growth. Hence every central bank targets certain inflation.
The norm is to have inflation around the two percent level. Therefore, the price stability refers to keeping inflation below or close target, or, below or close to two percent.
While it seems like a piece of cake, it isn’t that easy. Sometimes inflation drops or rises so fast that the ECB may end up being ahead of the inflationary curve or behind it.
For this reason, the ECB and other central banks too, have a research department, and its staff uses projections to simulate the inflation trajectory for the next months. Based on the projections, it sets the monetary policy on the Eurozone area.
The ECB meets every six weeks, on a Thursday, to communicate its interest rate decision. Forty-five minutes after the interest rate decision comes out, a press conference starts, with the President and Vice-President taking questions from press representatives.
Conclusion
Inflation levels determine whether the ECB is hawkish or dovish, raising the interest rates or cutting them. Hence, understanding inflation and its influence on the ECB decisions is critical for anyone trading the Euro.
