The European Central Bank (also known as the ECB) is the central bank for the euro area. It has the power to set monetary policy for the 19 Eurozone countries.
Its mandate is to create price stability for the euro area, which the ECB has defined as,
“avoiding inflation that is too high or too low.”
Here are the monetary policy tools used by the ECB to do this:
- Interest rates – this is the conventional form of monetary policy. The ECB sets the main refinancing rate (the level that banks are charged to borrow from the central bank). The ECB also sets the deposit rate (the rate that banks earn interest when they deposit money at the central bank).
- Asset purchases/reductions – this is the ECB’s unconventional monetary policy. The ECB can buy or sell government bonds of euro area countries. If the ECB needs to loosen monetary policy, it can buy bonds. If the ECB needs to tighten monetary policy, it can sell bonds.
The monetary policy actions of the ECB impact major Eurozone assets and markets, such as the euro (EUR), Eurozone government bonds and European equity markets.
The ECB’s mandate
Unlike the Federal Reserve which has a dual mandate, the ECB has said that its mandate is,
“to maintain price stability.”
However, in July 2021, the ECB’s Governing Council slightly adjusted its definition of price stability. The ECB now sees its mandate as being:
“price stability is best maintained by aiming for 2% inflation over the medium term”
The ECB uses the Harmonised Index of Consumer Prices (HICP) as its preferred measure of inflation.
The ECB’s Governing Council
The Governing Council of the ECB makes monetary policy decisions for the Eurozone. It is made up of:
- 6 Executive Board Members including a President, a Vice President, and four other board members (such as the ECB’s Chief Economist).
- 19 central bank governors of individual Eurozone countries.
The European Central Bank meetings happen every six weeks, where members vote on monetary policy decisions on rotation.
- The 6 Executive Board members have permanent voting rights.
- The 5 largest economies share 4 votes at every meeting (each gets a vote in 4 out of every 5 months).
- The remaining 14 members vote on rotation, voting for 11 months out of every 14 months.
The ECB’s decisions have the power to move markets, especially in Eurozone assets. It recently moved away from its Negative Interest Rate Policy (with rates now above zero), and so, the ECB meetings have now become far more impactful to traders.
However, as with all central banks, upcoming ECB meetings are closely watched for any indications of possible decisions. Speeches by ECB members also have the power to move markets.
Eurozone bond yields (such as the German Bund, the French OAT and the Italian BTP) are especially reactive to ECB decisions. This has a subsequent impact on the EUR. Equity markets such as the German DAX, French CAC and the EURO STOXX indices will also react.
Trading the European Central Bank
*Traders keep a watchful eye on moves in German bund yields but also core/periphery yield spreads. The spread of German bund yields versus the Italian BTP yields is seen as especially important.
This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. INFINOX is not authorised to provide investment advice. No opinion given in the material constitutes a recommendation by INFINOX or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. All trading carries risk.