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European Central Bank: Role and Importance for Euro Traders

Money differs today than in other period in humankind history. Back in time, silver and gold coins were the definition of money.

Nowadays, almost every country has its own physical money. Or, fiat money.

Mostly banknotes, but also coins, money represent the form of a currency in society. Either physical or just numbers in a bank account, money’s value changes over time.

Moreover, one can own money in different currencies. Hence, he/she is exposed to various valuations. The currency portfolio fluctuates with the changes in value between the currencies involved.

Saving money doesn’t always help. If you live in Zimbabwe, or Venezuela these days, keeping money in the local currency won’t do you any good.

But saving or owning money in different currencies, or in the right currency, is a different story.

The number one reason why a currency changes its value is its central bank. Sometimes, the central bank can’t do much to stop market forces. That’s the case in small and regional economies, where decisions taken by more powerful central banks in the world will play a bigger role.

Introducing the ECB

One such central bank is the European Central Bank or the ECB. An independent entity, ECB supervises the Euro (the common currency in the Eurozone) and sets the monetary policy for the economies of the nineteen countries where the Euro is present.

The ECB and Euro were born at the end of a daring process: to unify Europe via the European Union (EU).

The EU appeared to address the global influence major powerhouses had: China, Russia, United States, and some Asian countries too. With over five hundred million in population, the EU sits in a different position on the negotiating table than any powerhouse in the world.

Since its inception, international trade treaties were signed with most of the countries, but on better European terms.

The Eurozone economies make up the second largest economy in the world. Only the United States sits above, but not that far away.

But both the Euro and the European Union faced difficult times. The 2008 financial crisis in the United States caught many parts of the world unable to withstand the difficulties. Eurozone was one of them, with most financial institutions being on a verge of collapse.

The Greek and Cyprus crisis followed. Contagion fears saw investors fleeing from Southern countries like Italy, Spain, Portugal. The European project was endangered.

If there was one institution that could solve such a crisis, it was the ECB. And, it did.

Setting the monetary policy over nineteen different economies is no easy task. The ECB model is built on the Federal Reserve of the United States, but with some differences.

While the Fed has regional banks throughout the country, the Eurozone has national central banks that implement the ECB monetary policy. The decision-making process also differs.

In Forex trading, only the Fed dwarfs the ECB in the swings it creates when it changes the federal funds rate on the dollar. And that’s just because of the dollar’s role as a world’s reserve currency.

ECB’s Role in Forex Trading

With its headquarters in Frankfurt, Germany, the ECB vows to offer price stability and to conduct monetary policy to stimulate growth. As a mandate, it watches over inflation, with a target to bring and keep it below or close to two percent.

For this reason, everything surrounding the Euro depends on inflation, inflation expectations, and what the ECB will do next. In turbulent times, like the ones mentioned earlier, monetary policy takes a setback. It becomes secondary in importance when the status of a currency is questioned.

When it comes to money, trust is everything. After all, a one hundred Euro banknote costs only a fraction to produce.

However, it’ll buy goods and services worth one hundred Euros. As such, the buyer trusts the banknote will be of further use. It keeps value and trusts the issuer: the ECB.

But trust is relative. And, there’s no better place to see it than Forex trading.

In general, markets are eternally optimistic. Even when bad things happen, like an economic crisis, downturn, recession, etc., financial markets will always look at the next step that shows improvement.

The intrinsic value of a currency is not what it is worth. But what people trust it is worth.

Is it worth keeping my savings in a specific currency? If I trust the central bank and its actions, that’s as good as trusting the value of the money it supervises.

In desperate times (and not only), central bankers also use verbal intervention to calm markets. The most famous of them all happened during the recent financial crisis.

While in London, during a speech, the current ECB President, Mario Draghi, said the ECB would do “whatever it takes” to preserve the Euro. And he continued: “and believe me; it’ll be enough.”

As it turned out, fast forward a few years, it was enough. But financial markets and Forex trading participants didn’t wait for a second after Draghi’s remarks.

The Euro was bought in furry, with many dovish opinions being taken by surprise. While it took time for the ECB to put in place various mechanisms, it did so in style, as it regained market confidence.

Without confidence or trust, a currency’s value vanishes in a blink of an eye. In the end, a comparison like this belongs to all aspects of human relations.

So, the first, last, and most important role of the ECB in Forex trading is to establish trust for the Euro, the Eurozone, and the European project. And, to keep it that way.

The reason I chose the ECB to illustrate the tight relationship between trust and money is that Eurozone was subject to so many turbulences in recent history, that few gave the ECB a chance to fix things. Plus, historically, the Euro and the European Union didn’t stand a chance: no monetary union survived the test of time until now.

But times change, approaches change, and perceptions too. Just look at the new cryptocurrencies: if there’s trust that someone can use it to buy value, the market will strive.

Conclusion

Together with other major central banks in capitalistic countries, the ECB is one of the pillars of the financial system as we know it. Actively participating in targeting inflation and in close relationship with other jurisdictions, the ECB takes part in monetary decisions that affect the entire world, not only the Eurozone.

For example, when the Eurozone was in trouble, the ECB was in desperate need of dollars, and the Fed opened direct swap lines with the ECB. When the tsunami hit Japan, major central banks in the world, ECB included, provided help via access to incredibly cheap funding.

Moreover, all central banks meet regularly under the BIS (Bank of International Settlements) supervision, to coordinate their monetary policy actions.

As such, in Forex trading, the ECB plays a crucial role. Not only does it set the monetary policy for the Eurozone countries, but it does so in full cooperation with other economies around the world.

If this is not the very definition of capitalism, then nothing is! And it all started from the need to protect the trust in a currency: the most important aspect for a central bank.