The European Central Bank oversees the supply of euros.
Does that sound important?
You probably know the second most transacted currency in the world is the euro (after the American Dollar).
But what factors influence the ECB’s decisions?
What makes the supply of euros go up or down?
Let’s jump right in.
If you’ve seen my piece on the Bank of England (BoE), then you won’t be surprised by the European Central Bank’s mandate.
According to the ECB’s official page:
“The main objective of the Eurosystem is to maintain price stability: safeguarding the value of the euro”.
Again, price stability is no other than our dear friend: inflation.
Does the ECB care only about inflation?
But it IS its most important target.
The European Central Bank has an inflation target.
Currently, they seek to maintain inflation close to (but below) 2% per year.
This target changes as economic growth and the shape of the economy shifts (very long time frame), but this serves as an example.
Ok, but what happens if we’re away from the target?
Depends on which side of the coin you’re on.
If inflation is significantly below 2% (current target), then the ECB will consider cutting rates in order to stimulate the economy and have inflation pickup.
On the other hand, if inflation is above 2% or increasing too rapidly towards 2%, then the ECB will be prone to consider tightening conditions (hike rates).
Here at forexeconomist.com, I’ve talked a lot about why Central Banks feel the pressure to avoid high inflation by hiking rates (price instability).
But I feel like we haven’t covered the other side of the coin enough.
Why is low inflation bad?
I’ll probably make an article about this, but the gist of it is this:
A Central Bank can boost an economy’s growth by lowering interest rates.
So, if for example, the Eurozone enters a recession, the ECB can decrease rates to boost investment (money is cheaper), and thus increase economic activity.
But there’s a limit to how much you can lower rates.
If inflation is too low (or zero, or negative, as it’s been in Japan), the economic mechanism breaks down.
Lowering rates won’t boost the economy.
I’ll explain that more in-depth for anyone who cares in a different article.
we’re all about the European Central Bank here, so let’s move on.
As you know, the biggest market-moving events are monetary policy decisions taken by Central Banks.
So who makes those decisions at the ECB?
And how often are these decisions taken?
Rate decisions are taken by the ECB’s Governing Council.
The council meets twice a month at the ECB’s quarters in Frankfurt.
However, interest rate decisions are made every six weeks.
You can visit the ECB’s webpage for a calendar, but most FX economic calendars on the web will have these marked.
Ok, but how is the Governing Council structured?
It has 25 members…
Yes, since the Eurozone packs a bunch of countries together, you can’t expect them to sit on the sidelines can you?
Of these 25 members, 6 are part of the Executive Board, while 19 are the governors of their respective country’s Central Bank.
(Yes, each European country has its own national Central Bank).
However, only the 6 Executive Board members have permanent voting rights, while the rest of the governors rotate monthly (in voting).
Ok, so if the ECB’s council is so big, can you keep up with their hawkish/dovish leanings?
You can focus on what the Executive Board members have to say.
And you can check with news feeds or other sources what the expectations are for a given monetary policy decision.
This is where having a pricey news feed pays off.
But aside from that, what else can we glean from all this?
Remember the ECB’s mandate is to keep inflation in check.
Thus, the most important data releases will be CPI and anything else which will show inflationary pressure (you can check them on Forex Indicators).
Every other data release has to be seen under the loop of “how does this affect the ECB’s outlook on inflation?”
And as always, I must remind every reader out there:
Data releases, even CPI, won’t affect the markets unless the Central Bank is purposefully checking it out in order to make its rate decisions.
Wait, CPI won’t always matter?
Isn’t that crazy?
Imagine a scenario where CPI has printed too high an inflation mark for a while, and the European Central Bank has to hike rates.
In this case, a lower than expected CPI reading just before the fateful decision won’t likely change the outcome.
There are other scenarios where the Bank may not care as much, but in many instances, it will.
You just have to be aware of it in the moment.
And this ends another satisfying session of “let’s talk our guts out” so to speak.
Hope it was useful.
See you soon,
The Forex Economist
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