What is the European Central Bank?

As the name suggests, the European Central Bank is the central bank of Europe and is widely known by its acronym ECB. The ECB is responsible for overseeing the monetary and banking system in the euro zone and is at the top of the banking structure.

A common misconception is that the ECB prints all outstanding euro notes. That's actually the job of a national central bank like the Banque de France or the Deutsche Bundesbank. While the ECB creates money when it lends to banking institutions during the purchase of bonds or mortgage securities, these exchanges are credited electronically in what is known as liquidity.

The ECB's role in the financial and monetary system

The EU is the single largest trading bloc in the world, and millions of businesses and consumers depend on a sound financial system. Therefore, the role of the ECB in regulating and preserving the value of the common currency is very important. The main concern of the ECB is price stability and the preservation of the value of the EUR. The main objective is to keep inflation growing at around 2 percent per year.

The central bank has the power to set interest rate guidelines, which are followed by the entire banking sector – 5,963 banks – in the 27 EU member states, who sell their services to 341 million consumers in the euro zone. The ECB sets the overnight rate that banks use to lend money to each other. The ECB also pays the same interest rate to banks that hold reserve funds at the central bank.

Relations between the ECB and the Eurogroup

The Eurogroup is an informal group of all EU finance ministers who meet to discuss today's biggest financial and economic issues. As the principal supervisor of the banking and financial sector, the ECB works closely with the Eurogroup to find solutions to challenges in financial markets. One example is the sovereign debt crisis that began in 2009 when Greece and other European Union countries defaulted on their sovereign debt.

How the ECB influences trading and investment decisions

The ECB has great influence over trading and investment decisions and its interest rate decisions can move the EUR currency pair depending on the circumstances. Higher or lower central bank interest rates affect various markets:

commodity market

forex market

Mortgage and corporate loans

Invest in stocks

Bank share expectations and earnings per share

For this reason, traders and investors follow the ECB's monthly monetary policy and interest rate decisions closely and use them to decide on foreign exchange trading or stock market investments.

ECB and business news

The ECB uses a lot of technical terms in its monthly report, let's break it down.

price stability: typical expectations of daily prices paid by consumers and businesses.

inflation: the rate at which the average price of goods and services rises or falls each year.

Quantitative Easing (QE): Also known as an asset purchase program, where the ECB buys assets such as corporate and bank bonds in addition to government bonds. When the economy is in recession and inflation is relatively low, central banks can use QE to support the financial system and avoid debt defaults.

currency reserves: The ECB maintains large holdings of foreign exchange and gold reserves to support its monetary policy objectives and to shore up its own financial position.