The European Central Bank pushed ahead with a half-point hike in interest rates on Thursday, sticking to its previously announced anti-inflation plan, but said the recent turmoil in financial markets had made the future more uncertain.
In recent days, since the collapse of three mid-tier banks in the United States, investors have been swept away by concerns about other banks, including major Swiss lender Credit Suisse, and about the the sector’s ability to absorb higher interest rates. The European Central Bank became the first major central bank to set monetary policy since volatility began late last week.
Policymakers “were closely monitoring the current market tensions,” Christine Lagarde, the bank’s president, said in a news conference on Thursday. The bank “stands ready to respond as necessary to safeguard price stability and financial stability in the euro area,” she added.
Despite the added uncertainty, policymakers did not stray from the half a percentage point rate hike they first said was coming in early February. The bank said it would raise its deposit rate to 3 percent on Thursday, the highest since October 2008.
“Inflation is likely to remain too high for too long,” Ms Lagarde said, adding that the move was necessary to ensure inflation’s “timely” return to the bank’s 2% target. Bank officials have forecast inflation to average 5.3 percent this year and still be slightly above the 2 percent target in 2025.
What follows in the coming months is less clear. If the bank’s economic forecasts hold true now that the current market uncertainty has abated, Ms Lagarde, then policymakers “still have work to do” to tighten monetary policy. But that’s a big if.
And that was a marked change from the past few months, when the central bank had been showing investors the way forward and committing in advance to their next rate move.
The data used to produce the forecasts was finalized in early March, ahead of the recent market turmoil, leaving policymakers facing even greater uncertainty in their decision-making, Ms Lagarde said.
There was “a level of uncertainty that existed beforehand, but that was certainly compounded by the recent financial tensions that we’ve been observing over the past few days,” Ms Lagarde said. “It is obviously difficult for a group of 26 members of the Governing Council to come to a decision given the incoming economic and financial data,” she added.
“We were certainly confident that this 50 basis point rate hike was a solid decision considering the bottom needs to be covered,” she said, but later noted that some policymakers wanted more time to see how the situation develops.
In Frankfurt, where representatives of the European Central Bank met on Thursday. The bank said it was “ready to respond as needed to safeguard price stability and financial stability in the euro area”.Credit…Michael Probst/Associated Press
As financial markets collapsed this week, traders reduced bets on how much major central banks will hike interest rates this year amid the fallout from the collapse of California’s Silicon Valley bank and concerns over Credit Suisse. Analysts have begun to speculate that the Federal Reserve will not be able to continue with higher interest rates as expected as markets remain nervous about the health of many banks, particularly US regional banks, and their ability to withstand higher interest rates to withstand. The Fed and Bank of England are both expected to meet next week to set interest rates.
The euro zone has little direct exposure to Silicon Valley Bank, but banking worries drew much closer on Wednesday when Credit Suisse’s share price fell to a record low after the Swiss bank said it had a “material weakness” in its financial reporting controls found that its largest shareholder was reluctant to inject further funds for regulatory reasons. Credit Suisse said early Thursday it would borrow up to 50 billion Swiss francs, or about $54 billion, from the Swiss central bank and buy back some of its debt. Hours later, Credit Suisse shares jumped higher at the start of trading and ended the day nearly 20 percent higher.
The European Central Bank on Thursday stressed it has tools in place to protect financial stability in the region but said the banking system was “resilient, with strong capital and liquidity positions”.
It also highlighted a new tool, the anti-spill tool created over the summer, which could be used to counter “unwarranted, disorderly market dynamics” that threaten the central bank’s ability to implement its monetary policy decisions.
The central bank is fighting “the two problems of price stability and financial stability with two separate instruments in order to avoid conflicting goals,” writes Jörg Krämer, chief economist at Commerzbank, in a statement. There are good reasons for this, because “the deep-seated inflation problem has not changed so far”.
He expects the bank to hike rates by a quarter point at each of its next two meetings and cut the deposit rate to 3.5 percent, down from a previous forecast of 4 percent. The market turmoil could “dampen bank lending – and with it growth and ultimately inflation,” Mr. Kramer added.
Ms Lagarde stressed that future interest rate decisions are “data dependent”, which includes financial data. The bank would be particularly vigilant about lending to households and businesses, as well as restrictions and the extent of tightening of financing conditions for the economy.
“It is not possible to say at this stage how the path will continue,” European Central Bank President Christine Lagarde told reporters after Thursday’s bank meeting in Frankfurt.Credit…Heiko Becker/Reuters
Last month, ECB policymakers said they expect to hike rates by half a point at this week’s meeting because they are determined to stamp out persistent inflationary pressures, even as inflation appears to have peaked. Consumer prices in the 20 countries that use the euro as their currency rose at an annual rate of 8.5 percent in February, slightly below the rate in January and below the peak of 10.6 percent in October.
Aside from the headline inflation rate for the eurozone as a whole, the details were more worrying for some policymakers. Some major economies, including France and Spain, reported higher inflation rates. Core inflation, which excludes volatile energy and food prices and is used to measure how embedded inflation is in an economy, also rose last month.
Lower wholesale energy prices in Europe will help push inflation towards the central bank’s 2% target. But policymakers are focused on so-called underlying inflation, which will show whether inflationary pressures are still building up and making it difficult to meet the inflation target on a sustainable basis. Metrics such as wages and services inflation are closely monitored and current underlying inflation trends do not confirm that inflation is nearing target.
Regarding inflation, “we’re seeing slight improvement in certain areas, but honestly not much,” Ms. Lagarde said.
While markets remain jittery and the extent of the impact on the banking sector is still unknown, there is a risk that central banks could appear to be sidetracked from their inflation-cutting goals after spending months warning that high prices could last longer than expected.
But Ms. Lagarde tried to resist suggestions that the European Central Bank would prematurely declare victory in the fight against inflation. “We remain committed to fighting inflation,” she said. ‘ That should not be doubted. The resolve is intact.”
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