LONDON (CNN) The European Central Bank stuck to its plan to raise interest rates by half a percentage point on Thursday, ruling that inflation poses a greater threat to the economy than turmoil in the banking sector.
However, the ECB said it was closely monitoring “current market tensions” and was “ready to react as necessary to safeguard price stability and financial stability in the euro area”.
The central bank has the tools it needs to respond to a liquidity crisis, “but that’s not what we’re seeing,” ECB President Christine Lagarde told reporters.
Lagarde and Vice President Luis de Guindos stressed that European banks are much more resilient than before the global financial crisis, with strong capital and liquidity positions and no concentration of exposure to Credit Suisse (CS).
A “relief” for the markets
European bank shares rose Thursday afternoon, recovering from earlier losses following the ECB’s rate hike.
“A sort of relief for markets this afternoon after the ECB meeting,” said Christophe Boucher, chief investment officer at ABN AMRO Investment Solutions.
Some analysts had expected the central bank to opt for a smaller 25bps hike to offset inflationary pressures against the risk of further stress in markets, particularly after bank stocks sold off sharply on Wednesday and Credit Suisse requested a lifeline from the Swiss central bank had tapped into.
But the markets remained “relatively stable” thereafter. ECB announcement, said Boucher, “which ended up not causing any surprises”.
Lagarde said the decision to raise 50 basis points was taken by a “very large majority… and in quite record time.” However, unlike previous meetings, it did not announce any further rate hikes, suggesting the central bank may now pause to take stock.
The The latest from the ECB move takes the reference interest rate in the 20 countries that use the euro to 3%. The central bank has now hiked interest rates for six straight meetings since July in a bid to get inflation under control.
“Inflation is likely to remain too high for too long,” the ECB said on Thursday, adding that core inflation – barring volatile energy and food prices – continued to rise in February.
At 8.5%, eurozone inflation last month was well above the central bank’s 2% target. And Wednesday’s data showed a stronger-than-expected increase in industrial production across the euro area.
“The ECB did today the only thing you would expect a central bank with a price stability mandate to do when inflation is more than double the target,” said Sylvain Broyer, chief economist for Europe at S&P Global Ratings.
“Potential vulnerabilities in the banking system should be addressed through policy tools other than interest rates. The ECB has many such tools at hand,” he added.
Banking turmoil could weigh on the economy
There are growing concerns that last week’s demise of Silicon Valley Bank, which hit bank stocks hard, could prompt banks to be more cautious about lending. That would weigh on economic growth and inflation and reduce the need for rate hikes.
Lagarde acknowledged that “persistently heightened market tensions” could further constrain already tightening credit conditions. Credit growth to households had slowed further since the ECB’s last meeting as higher borrowing costs eased Demand.
A “weakening of bank lending would contribute to lower price pressures than currently expected,” she added.
Based on forecasts made in early March before the SVB collapsed, ECB officials now see inflation averaging 5.3% in 2023, lower than the 6.3% they forecast in December.
High levels of uncertainty reinforce the importance of letting economic data guide policy decisions, said Lagarde. She stressed that the ECB’s determination to fight inflation and bring it back to 2% remained “intact”.
Salomon Fiedler, an economist at Berenberg, said that ahead of its next meeting in May, the ECB “needs to assess how much financial conditions are tightening in response to the recent shocks – and how much economic momentum and inflation are slowing without them.” would further ECB action.”
The Federal Reserve and Bank of England will have to make a similar call when they meet next week to set interest rates.