How does monetary policy relate to exchange rates?

Although the European Central Bank (ECB) does not set the exchange rate of the euro, it can influence it indirectly through its monetary policy.

Taking the EUR/USD exchange rate as an example (see What are exchange rates?), if the ECB increases its policy interest rates, assuming that the US central bank (the Federal ReserveOpens in new window) makes no changes to its interest rate, the euro will become more attractive to investors and demand for euro will increase. This will make the euro appreciate. In other words, increasing a country’s interest rate can cause its currency to appreciate.