Exchange rate policy
The exchange rate is not an instrument of the Eurosystem’s monetary policy. This means that when implementing monetary policy the Eurosystem does not aim to affect the euro exchange rate, hence the rate fluctuates freely against many other currencies. The ECB takes the exchange rate into consideration only insofar as it influences price stability in the euro area. For example, downward movements in the euro exchange rate increase prices of imported goods, which may put upward pressure on inflation. Hence, an excessively rapid rise in inflation may provide impetus for resorting to monetary policy instruments.
If necessary and without prejudice to the ECB’s primary objective of maintaining price stability, the Eurosystem may conduct foreign exchange interventions.
In addition, the Treaty on the Functioning of the European Union (paragraphs 1 and 2 of Article 219) allows the ECOFIN Council to fix the exchange rate of the euro against other currencies or limit fluctuations in the euro exchange rate in any other way. Such limitations should also be in line with the ECB’s primary objective of maintaining price stability. Until now, decisions regarding constraints on the euro exchange rate were only adopted when setting the fixed central euro exchange rate and its fluctuation band vis-à-vis national currencies of countries participating in the Exchange Rate Mechanism II.
Currency market interventions
Foreign exchange interventions occur when a central bank purchases or sells foreign currency in order to influence the exchange rate of national currency. The Eurosystem may conduct such interventions on its own (i.e. unilaterally) or together with other non-euro area central banks (i.e. coordinated action). The interventions of the Eurosystem may be carried out either in a centralised manner, i.e. directly by the ECB, or in a decentralised manner, i.e. by euro area NCBs acting on behalf of the ECB. When necessary, the Eurosystem may conduct foreign exchange interventions to:
- minimise excessive fluctuations in the euro exchange rate;
- stabilise the euro exchange rate vis-à-vis currencies of other EU countries participating in the Exchange Rate Mechanism II;
- implement decisions of the ECOFIN Council on the other systems of or general guidelines for the euro exchange rate, if there were any in the future.
Exchange Rate Mechanism II
The Exchange Rate Mechanism II (ERM II) helps to test the sustainability of convergence between EU countries and the euro area and the readiness of EU countries to join the euro area. The mechanism was introduced on 1 January 1999. Sustainable stability of the exchange rate against the euro is one of the convergence criteria for EU Member States seeking to adopt the euro. Each EU Member State participating in the mechanism and euro area countries set a fixed central rate of the national currency of an EU country against the euro with a standard fluctuation band of ±15%, which might be reduced by mutual agreement. Lithuania was a participant in ERM II from 28 June 2004 to 31 December 2014, having unilaterally maintained the fixed exchange rate of its national currency – litas – against the euro without any fluctuations over the whole participation period. Currently, only Denmark participates in ERM II. By mutual agreement, the Danish krone can fluctuate against the euro by ±2.25%.