ECB raises rates to signal market turmoil will guide next steps

Prior to crunch UK central bank meetings next week, benchmark increases will be from 2.5% to 3.3%The European Central Bank announced a half-point increase in interest rates for Thursday, despite financial turmoil. Future increases will depend on market panic that has subsided in recent days.

The ECB decided to raise its benchmark deposit rate by 2.5 percent to 3%, in line with what was promised last month. This decision came before the crunch policy votes of rate-setters from the UK and US next week.

This meeting was intended to test policymakers’ willingness to continue raising rates, despite the increased stress on banks following the collapse of Silicon Valley Bank and concerns over Credit Suisse.

The ECB’s governing board remained true to its February meeting plan, but its members abandoned a commitment to “raising interest rates substantially at a steady rate” as a sign that they are uncertain about how much they can increase borrowing costs. This was despite the fact that inflation remains “too high”.

Christine Lagarde (ECB president) indicated that some members of the council wanted rates to be stopped as soon as possible. She said three or four members were still waiting for clarification on “how the situation develops.” The rate increase was carried out by the “vast majority”, to demonstrate confidence in the eurozone’s banking system.

Katharine Neiss is an economist at investor PGIM Fixed Income. She said that the ECB’s new guidance was “a noticeable shift towards a more dovish ton”, and that it “opens up the possibility that this hike might well be the last, at least for the foreseeable near future.”

Credit Suisse shares and other European banks recovered some losses from Thursday’s announcement by Switzerland’s second-biggest lender that it would borrow up SFr50bn (54bn USD) from the Swiss central banking and purchase back approximately SFr3bn in its debt to increase liquidity and calm investors.

On Thursday morning, eurozone rate-setters were relieved by the intervention of the Swiss central bank. One said that it had “stopped panic” While stating that eurozone banks are “resilient”, with strong capital and liquidity positions, the ECB stressed that it has the tools to provide liquidity support if necessary.

While the central bank reduced its inflation forecasts over the next three year, it said that price pressures would still be “projectioned to remain too strong for too long”. Pictet Wealth Management economist Frederik Ducrozet said he wasn’t sure if the ECB had stopped raising rates, but that they had given themselves a lot of flexibility to pause.

As Lagarde answered journalists’ questions, the euro fluctuated between gains and losses in relation to the dollar. Germany’s two-year rate-sensitive borrowing costs rose 0.17 percentage point to 2.57 percent, partially reversing recent declines.

The Bank of England and the US Federal Reserve are more likely to wait and see than the ECB.

Economists stated that central banks are entering a new phase of their efforts to control decades-high inflation. They will need to balance monetary tightening and prevent a financial crisis.

Krishna Guha, the head of policy and central banking strategy at Evercore ISI in the United States, stated that rate-setters will have to demonstrate they can “walk AND chew gum simultaneously — address financial stability concerns using financial stability instruments, while using rates to control inflation to avoid financial dominance”.

Lagarde said that there is no trade-off between the rates as rates can be used to combat inflation and other tools, including new ones, could be used to address financial turmoil.

Italy’s hard-right League party, headed by Matteo Salvini, criticised the ECB decision and warned that it could “artificially inciting a recession to fight poverty and inflation”.

The European Trade Union Confederation was also disappointed. Its general secretary Esther Lynch stated that the ECB’s move was “pre-emptive” and “reckless at a moment when banks are failing”, inflation is falling, and bankruptcies rising.

The central bank has lowered its quarterly inflation projections for this year, from the 6.3% expected in December to 5.3% and for next year to 3.4% to 2.9%.

Although prices will grow slightly less than expected in 2025, they still exceed the 2 percent target of 2.1 percent. Core inflation, which excludes energy and food, will be higher than expected at 4.6% this year. This indicates that more policy tightening may be necessary.

“If our baseline were to prevail when uncertainty decreases, then we know that we still have a lot to cover,” Lagarde said, adding that there was “a big caveat”, as its forecasts were made using data prior to the current banking crisis.

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