It complicates the decision of the European central credit institution, which wants to fight persistent inflation, but without destabilizing the capital markets
Turmoil in the banking sector is testing the resolve of the European Central Bank, which was expected today to announce another half-point interest rate hike to fight inflation, but may be cautious.
The sector’s biggest post-crisis bank failure in 2008, that of Silicon Valley Bank (SVB), poses an additional challenge to the ECB’s interest rate steering, despite actions and statements by authorities and leaders on both sides of the Atlantic that downplay the risk of transmission.
The concern went up a notch yesterday, with an unprecedented drop in the share price of Crédit Suisse, the Swiss banking giant, which dragged down other European stocks.
The plunge began after the statements of the new major shareholder of Crédit Suisse – and chairman of the National Bank of Saudi Arabia – who called into question its support for the bank, which is considered to be in a vulnerable position.
This turmoil complicates the decision of the European central credit institution, which wants to fight persistent inflation, but without destabilizing the capital markets.
“It’s not that painless”
Until recently, a 50 basis point interest rate hike at the ECB’s monetary policy meeting today was more or less a foregone conclusion, having been announced by the ECB itself last month. But markets are now not ruling out an increase of 25 basis points, or a quarter of a percentage point.
The situation is not expected to “convince the ECB” to raise its interest rates by an additional 50 basis points “due to persistently high inflation”, according to Agnieszka Ortolani, an analyst at the Economist Intelligence Unit (EIU).
That decision would raise interest rates on unallocated bank liquidity to 3.0%, the highest level since 2008.
As commodity prices soared, largely due to Russia’s military incursion into Ukraine, the ECB began a rate hike in July, ending nearly a decade of cheap money.
This almost forced monetary tightening, which major central banks are trying to push up the cost of credit and slow overheating prices, has also helped to hit commercial banks.
Something that is expected to preoccupy the dialogue that the central bankers of the euro zone will have today about the pace that will be followed in the coming months.
The turmoil in the banking sector proves that “the rise in interest rates is not as painless as it seemed”, which seems to vindicate the “doves” who recommended a more cautious approach, according to Gilles Moeck, chief economist of the AXA group.
The “hawks”, who want the tighter policy to continue, say they see no risk of contagion in the economy and therefore “it has no impact on the formulation of monetary policy”, according to Mr. Moek.
As the battle against inflation is far from over, the ECB remains under pressure.
Inflation in the eurozone fell in February, for the fourth consecutive month, to 8.5% on an annual basis, but the price curve excluding energy and food increased by 5.6%, at a record level.
New inflation and growth forecasts, published today by the institution, will help to reassess the situation.
Peak at 3.5%?
The president of the ECB, Christine Lagarde, will need to weigh her every word on the future development of interest rates.
“The extreme uncertainty that prevails today in the US banking sector and the reaction of the markets is expected to push the institution to show more caution” according to Frederic Dicrozer, chief economist of Picter Wealth Management.
The level of deposit rates could peak between 3.5% and 4% in the summer, according to observers, who think it is more likely to stay closer to the lower end of the spectrum.
“The risk to financial stability” is forcing markets to “revise the trajectory of interest rates downward,” according to bank ING.
The ECB can also fight inflation by reducing the stock of government and private debt and giant bank loans on its balance sheet.
This tool, which Allianz economist Ludovic Subran describes as a “monetary respirator”, is of critical importance at a time when European banks are not short of liquidity and risks of financial “accidents” are looming.
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