March 18, 2011 / 10:37 AM / 9 years ago

FACTBOX-How ECB currency intervention works

FRANKFURT, March 18 (Reuters) - The European Central Bank has intervened alongside Japan, the United States, the United Kingdom and others to calm volatile foreign exchange markets in the wake of Japan’s catastrophic earthquake, tsunami and nuclear disasters. [ID:nWEA9460]

Below is a factbox on how ECB currency interventions work and details of the central bank’s previous interventions.

HOW IT INTERVENES

* The ECB can intervene in the foreign exchange markets without prior authority from euro zone or EU finance ministers. It can conduct sales or purchases of foreign exchange itself, or instruct national central banks that manage ECB reserves to conduct transactions on its behalf, or ask the same of foreign central banks with which it holds accounts.

* The ECB also can instruct the national central banks to transfer their own foreign exchange assets to the ECB, in exchange for an interest-bearing claim. This would increase the ECB’s fire power about four-fold, but it has never used this authority.

* The ECB can fund foreign exchange interventions not only with its reserves but by other means, such as foreign exchange swaps, and swaps with other central banks.

* The ECB can fire its biggest cannon by coordinating its foreign exchange intervention with other major central banks.

In September 2000, it initiated a plan where the U.S. Federal Reserve and Bank of Japan joined it in buying euros to stem the single currency’s sharp slide.

The action was followed by three waves of unilateral ECB intervention in November and succeeded in putting a floor under the euro at 82 cents. There had been no interventions since until Friday’s move.

INTERVENTION POWERS

* The European Central Bank must conduct its foreign exchange operations within the framework of its primary objective, maintaining price stability. This means that if changes in the euro’s value threaten inflationary or deflationary pressures, the ECB can intervene in the foreign exchange markets if price stability is at risk.

* European Union finance ministers have the authority to reach agreements on an exchange rate system for the euro, and can give general directions for exchange rate policy. The ECB can provide them with advice on these matters. The European Council of EU leaders agreed that it would exercise these powers in exceptional circumstances and without threatening the independence of the Eurosystem — the ECB and national central banks.

In practice, EU finance ministers have never used these powers, leaving decisions on the euro and exchange rate policy up to the ECB.

* The ECB has a strong incentive to consult with finance ministers and keep them abreast of its thinking and any foreign exchange policy plans, because ministers have the authority to give currency direction. The monthly Eurogroup meeting of euro zone finance ministers and the ECB president is the usual forum for these discussions.

See also here

FX RESERVES

* There was a total of 185 billion euros in foreign exchange reserves in the European System of Central Banks (ESCB) as of the end of last week. ECB does not specify currency composition of its reserves, but traditionally they are held substantially in dollars.

* National central banks are required to contribute to the ECB reserves when they join the Eurosystem, based on a formula.

* The ECB manages its foreign exchange reserves to generate some income but it keeps them in highly liquid instruments. Some of the reserves are managed on its behalf by the national central banks. The ECB also has reserve accounts with other central banks, such as the Bank of Japan and the Federal Reserve. (Reporting by Marc Jones)

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