A timely return to price stability cannot be taken for granted

The European Central Bank (ECB) in Frankfurt, Germany is the reserve bank for the euro area. The ECB sets interest rates and manages monetary policy for the region. The ECB’s main mandate is to maintain price stability, which means keeping inflation at around 2%. Its main tool to achieve this is by raising or lowering interest rates. Relatively high interest rates will usually lead to a stronger euro and vice versa. The Governing Council of the ECB takes monetary policy decisions at meetings held eight times a year. Decisions are taken by the heads of national banks in the euro area and six permanent members, including ECB President Christine Lagarde.

In extreme situations, the European Central Bank can implement a policy tool called Quantitative Easing. QE is the process by which the ECB prints euros and uses them to buy assets – usually government or corporate bonds – from banks and other financial institutions. QE usually leads to a weaker euro. QE is a last resort when simply lowering interest rates is unlikely to achieve the objective of price stability. The ECB used it during the Great Financial Crisis of 2009-11, in 2015 when inflation remained stubbornly low, and during the covid pandemic.

Quantitative tightening (QT) is the inverse of QE. It is undertaken after QE when an economic recovery is underway and inflation begins to rise. While in QE the European Central Bank (ECB) buys government and corporate bonds from financial institutions to provide them with liquidity, in QT the ECB stops buying more bonds and stops reinvesting the maturing principal in the bonds it already owns . It is usually positive (or bullish) for the euro.