European Central Bank raises interest rates by half a percentage point

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 banking sector turmoil.

But the ECB said it is closely monitoring “current market tensions” and is “ready to respond if necessary to preserve price stability and financial stability in the euro area”.

The central bank has the tools to respond to a liquidity crisis if necessary “but this is not what we are seeing,” ECB President Christine Lagarde told reporters.

Lagarde and Vice President Luis de Guindos stressed that European banks were much more resilient than before the global financial crisis, with strong capital and liquidity positions and no concentration of exposure to Swiss credit (CS).

A breath of fresh air for markets

Shares in European banks rose Thursday afternoon, recovering from earlier losses following the ECB rate hike.

“A sort of relief for the 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 25 basis point hike to balance inflationary pressures with the risk of further pressure on markets, especially after bank stocks sold off sharply on Wednesday and Credit Suisse drained a lifeline from the Swiss Central Bank.

But markets “remained relatively stable” after the Announcement from the ECB, Boucher said, “which ended up not being a surprise.”

Lagarde said the decision to raise by 50 basis points was made by a “very large majority … and in fairly record time”. However, unlike previous meetings, she gave no signal for further hikes, suggesting the central bank may now pause to take stock.

The The latest from the ECB move brings the benchmark rate in the 20 countries that use the euro to 3%. The central bank has raised interest rates at six consecutive meetings since July in an attempt to bring inflation under control.

“Inflation is expected to remain too high for too long,” the ECB said on Thursday, adding that core inflation – excluding volatile energy and food prices – continued to rise in February.

Inflation in the euro area was 8.5% last month, well above the central bank’s target of 2%. And data from Wednesday showed a stronger-than-expected increase in industrial production across the euro area.

“Today the ECB did the one thing one would expect from a central bank with a price stability mandate when inflation … is more than twice the target,” said Sylvain Broyer, chief European economist at S&P Global Ratings.

“Potential vulnerabilities in the banking system must be addressed with policy tools other than interest rates. The ECB has numerous such tools at hand,” he added.

Bank unrest can weigh on the economy

There are mounting concerns that the demise of Silicon Valley Bank last week, which hammered bank stocks, could lead banks to take a more cautious approach to lending. That would weigh on economic growth and inflation, reducing the need for rate hikes.

Lagarde acknowledged that “prolonged heightened market tensions” could further constrain already tighter credit conditions. Growth in loans to households had slowed further since the last ECB meeting, as higher borrowing costs eased ask.

A “weakening of bank credit would contribute to lower price pressures than currently expected,” she added.

Based on projections made in early March before the collapse of the SVB, ECB staff now expect inflation to average 5.3% in 2023, which is lower than the 6.3% they predicted in December.

A high degree of uncertainty reinforces the importance of being guided by economic data when making policy decisions, said Lagarde. She stressed that the ECB’s determination to fight inflation and bring it back to 2% remained “unshaken”.

Salomon Fiedler, an economist at Berenberg, said that before its next meeting in May, the ECB “will have to assess by how much financial conditions tighten in response to the recent shocks – and thus how much economic momentum and inflation would slow down even without further action from the ECB.”

The Federal Reserve and the Bank of England will have to make a similar call when they meet next week to set interest rates.






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