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Banking turbulence clouds European Central Bank rate hikes

Photo Credit: WOLFGANG RATTAY Photo Credit: WOLFGANG RATTAY
Photo Credit: WOLFGANG RATTAY Photo Credit: WOLFGANG RATTAY

European Central Bank officials are meeting on Thursday amid extraordinary financial market upheaval that might push it to abandon plans for another large interest rate rise as fears of a new financial crisis outweigh inflation concerns.

The ECB has hiked interest rates since July at its quickest pace to contain inflation, promising another 50 basis point (bps) increase for Thursday and more in the months ahead.

But, the collapse of Silicon Valley Bank in the US last week heightened fears about stress across the banking industry and sent shares plunging, with Credit Suisse, long plagued by troubles, leading to the European crash.

Shares rallied as the Swiss National Bank gave Credit Suisse a $54 billion lifeline on Thursday. Still, volatility kept markets under stress, worrying the ECB since monetary policy operates through the financial sector.

The ECB, the central bank for the eurozone’s 20 states, must balance its inflation-fighting mandate with financial stability in the face of mainly imported turbulence.

“The assistance offered by the Swiss National Bank to Credit Suisse eliminates systemic risk to the degree that the ECB will still be able to hike rates today by 50 bps,” said Lorne Baring, Managing Director of B Capital SA.

According to Reuters, the ECB’s updated economic estimates would show inflation well above its 2% objective in 2024 and slightly above in 2025.

Meanwhile, underlying inflation, an indication of price increase resilience, is expected to rise, signaling that disinflation will last and monetary policy will need to be tight.

Before the financial crisis, many officials supported rate rises beyond March.

Investors distrust the ECB’s resolve and have reduced bets on Thursday’s action and future rate hikes. Money market pricing predicts a 50% possibility of a 50 bps hike, down from 100% last week but still above the 20% priced on Wednesday.

The terminal rate, or top ECB rate, has dropped from 4.1% last week to 3.25%.

Several economists believe the ECB should abandon its tightening measures due to financial stress.

“Present trends classify as ‘severe’,” Barclays analyst Silvia Ardagna remarked. “We give 20% chance to no rise, 60% to a 25 bps hike, and 20% to a 50 bps hike.”

Even if the ECB hikes 50 bps, it will likely stop signaling its next move and leave the May meeting open, even if it still favors higher rates.

ECB President Christine Lagarde will likely reassure investors that the bloc’s banks are more capitalized, profitable, and liquid than in prior crises.

As it just eliminated a subsidy from a major liquidity facility to wean lenders off central bank funds, the ECB is unlikely to grant targeted bank aid.

Lagarde might indicate that the ECB is prepared to intervene if contagion weakens euro zone lenders and prevents the ECB’s monetary policy from working.

BNP Paribas said the ECB would keep to the separation concept, focusing on inflation and employing other measures for financial stability. As a result, interest rates are unlikely to solve a liquidity issue.


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