Since inflation poses a greater threat to the economy than banking sector turmoil, the European Central Bank decided to stick with its plan to raise interest rates by half a percentage point on Thursday.
However, the ECB stated that it “stands ready to respond as necessary to preserve price stability and financial stability in the euro area” and was monitoring “current market tensions” closely.
The national bank has the instruments if necessary to answer a liquidity emergency “however this isn’t how the situation is playing out,” ECB President Christine Lagarde told correspondents.
With strong capital and liquidity positions and no concentration of exposure to Credit Suisse (CS), Lagarde and Vice President Luis de Guindos emphasized that European banks were significantly more resilient than they were prior to the global financial crisis.
A ‘relief’ for markets
After suffering losses earlier in the day as a result of the ECB’s rate hike, shares of European banks rose on Thursday afternoon.
“A kind of help this evening for the business sectors after the ECB meeting,” said Christophe Boucher, boss speculation official at ABN AMRO Venture Arrangements. After banking stocks sold off sharply on Wednesday and Credit Suisse tapped a lifeline from Switzerland’s Central Bank, some analysts had expected the central bank to choose a smaller 25 basis point hike to balance inflationary pressures with the risk of adding more stress to markets.
However, Boucher stated that markets “remained relatively stable” following the ECB announcement, “which in the end did not create any surprises.”
Lagarde said the choice to climb by 50 premise focuses was taken by a “exceptionally larger part … and in rather record time.” However, in contrast to previous meetings, she did not hint at future increases, indicating that the central bank may now pause to evaluate the situation.
The most recent move by the ECB raises the benchmark rate for the 20 euro-using nations to 3%. In an effort to control inflation, the central bank has raised rates six times in a row since July.
The ECB stated on Thursday that “inflation is projected to remain too high for too long,” adding that core inflation, which excludes volatile energy and food prices, continued to rise in February.
The euro area’s inflation rate was 8.5% last month, well above the 2% target set by the central bank. Additionally, industrial production in the Euro Area grew more rapidly than anticipated, according to data released on Wednesday.
“The ECB did today the main thing one would anticipate from a national keep money with a cost strength command when expansion … is over two times the objective,” said Sylvain Broyer, boss European financial expert at S&P Worldwide Evaluations.
Policy instruments other than interest rates should be used to address potential banking system fragilities. There are numerous such instruments available at the ECB,” he added.
Bank turmoil could weigh on the economy
There are increasing concerns that the demise of Silicon Valley Bank this past week, which has had a negative impact on bank stocks, could cause banks to lend with greater caution. That would have a negative impact on economic expansion and inflation, making rate hikes less necessary.
Lagarde acknowledged that “persistently elevated market tensions” might make already-tightened credit conditions even more restrictive. Since the ECB’s last meeting, household loan growth had slowed further as higher borrowing costs stifled demand.
She went on to say that a “weakening of bank credit would contribute to lower price pressures than currently anticipated.”
The ECB staff now expects inflation to average 5.3% in 2023, which is lower than their December projection of 6.3%. These projections were made in early March prior to the collapse of SVB.
Lagarde stated that the significance of being guided by economic data when making policy decisions is heightened by the high level of uncertainty. She emphasized that the ECB’s resolve to combat inflation and bring it back to 2% was still “intact.”
According to Berenberg economist Salomon Fiedler, “the ECB will need to judge by how much financial conditions tighten in response to the recent shocks — and thus how much economic momentum and inflation would slow down even without further ECB action” prior to its subsequent meeting in May.
When they meet next week to set interest rates, the Bank of England and the Federal Reserve will have to make the same decision.