Exonuclease activity is an important feature of DNA polymerase III, allowing erroneous nucleotides to be removed where they are inserted into the DNA strand. This allows the polymerase to undo any errors, preventing mutation or distortions to the DNA.
In order to transfer the daughter strand to the exo site, the polymerase must backtrack. The hydrogen bonds between the most recent 3 nucleotides are melted, and the strand moved over to the exo site. This removes 1 nucleotide before the primer strand is returned to the pol site. The mechanism by which this occurs is not fully understood, and is an area of active research.