The European Central Bank (ECB) is the central bank responsible for the monetary system of the European Union and the euro currency. It was formed in 1998 and works alongside the national banks of each the EU members to create monetary policy and maintain price stability in the European Union.
Being a trader requires staying up-to-date on various market developments, news and macroeconomic releases. However, if we would have to pick only one specific report to follow, that would be a country’s monetary policy. Central banks determine the monetary policy of a country, and the European Central Bank, or ECB, is one of the most important central banks in the world.
Let’s take a closer look at what does ECB stand for.
What is the ECB
The ECB is an acronym abbreviation for the European Central Bank. The ECB administers the monetary policy of the 19 EU member states which use the euro as their currency and form the Eurozone. As such, the ECB is one of the most important central banks in the world, and is one of Europe’s major central banks along with the Bank of England and the Swiss National Bank.
Although the ECB is responsible for the monetary policy of 19 Eurozone member states, its capital stock is owned by the national central banks of all 28 member states of the European Union.
The main objective of the European Central Bank is to maintain price stability in the Eurozone, which is achieved through inflation targeting. Since the bank’s Governing Council decided in 1998 that price stability requires a yearly inflation rate of under 2%, the ECB targets a Harmonized Consumer Price Index (HCPI) of close to 2% by adjusting its monetary policy accordingly. Each ECB’s announcement to change its monetary policy is closely followed by market participants worldwide and has a direct impact on the value of the single currency – the euro.
The ECB also played a pivotal role in minimizing the consequences of the 2007-08 financial crisis on the Eurozone. The bank performed net asset purchases of bonds from weaker states, such as Italy and Spain, which in turn increased both the ECB’s total assets and euro supply in the market and helped to maintain a relatively low exchange rate of the euro.
What is the ECB Interest Rate?
The ECB’s interest rate is the rate at which the central bank charges advances and loans to commercial banks. Central banks lower their interest rates when the economy is struggling, in order to increase consumer spending and economic activity. Similarly, when an economy is expected to overheat in the long term, a central bank will increase interest rates to dampen inflationary pressures.
Just like other major central banks, the European Central Bank lowered its interest rates to spur economic activity in the aftermath of the 2008 financial crisis. Interest rates in the Eurozone reached a record low of 0.00% in March 2016, where they’ve remained ever since.
ECB’s Monetary Policy
The European Central Bank controls the circulating amount of euros, and hence their supply, through its monetary policy. The primary monetary policy tool of the ECB is collateralized borrowing, with the collateral consisting of high-quality debt securities. By buying large amounts of debt, the ECB is increasing the amount of money circulating in the economy to ensure that enough liquidity is present in the market. Similarly, by selling securities out of its balance sheet, the ECB is tightening the monetary policy.
Beside implementing Eurozone’s monetary policy, the ECB is also responsible to conduct foreign exchange operations, to monitor foreign reserves of national central banks, and to ensure a healthy and smooth financial market under the TARGET2 payments system.
The Single Supervisory Mechanism (SSM), introduced in 2014, aims to supervise the financial stability of commercial banks in the European Union in order to maintain a stable financial market and banking system. This supervision, conducted through the European Central Bank, should prevent future debt crisis in the euro area like the one seen in Greece in the aftermath of the 2007-2008 financial crisis.
Why Do Traders Care?
ECB’s monetary policy decisions have a major effect on the market. Traders should follow when ECB President Mario Draghi speaks, and watch out for hints of future ECB decisions regarding its monetary policy. Each upcoming Mario Draghi conference can be found in economic calendars, or directly on the bank’s website at the following link: www.ecb.europa.eu.