Despite banking turmoil, the ECB rises rates as expected

In spite of the financial market chaos and investor calls to pause policy tightening at least until sentiment stabilizes, the European Central Bank increased interest rates by 50 basis points on Thursday as planned.

The European Central Bank (ECB) has been raising interest rates at their quickest rate ever to combat inflation, but a rout in world markets following the failure of Silicon Valley Bank in the US last week had threatened to derail these plans at the last minute.

The central bank for the 20 countries that use the euro raised its deposit rate to 3%, the highest level since late 2008, in accordance with its frequently repeated guidance, as inflation is anticipated to exceed its 2% target until 2025.

Although a long list of policymakers had previously called for more significant actions to be taken in the battle against inflation, it made no future commitments.

The ECB stated that "the elevated level of uncertainty reinforces the importance of a data-dependent approach to the Governing Council’s policy rate decisions."

Financial market participants had projected a 50% chance of a smaller, 25 basis point increase by the ECB on Thursday morning, following days of market turbulence. They have also lowered expectations for next moves, projecting a top rate of 3.25%, which is lower than the 4.1% priced last week.

The collapse of SVB and the subsequent decline in the value of Credit Suisse, a company that has long been plagued by issues, sent euro zone bank shares into free fall this week.

But, Credit Suisse was given a $54 billion lifeline by the Swiss National Bank last night, which was a significant enough show of force to propel its shares back up by about 20% and boost other bank equities.

The main concern for the ECB is that because monetary policy is carried out through the banking system, an extensive financial crisis would render it ineffective.

As a result, the ECB was forced to choose between upholding financial stability in the face of overwhelmingly imported turbulence and fulfilling its responsibility to combat inflation.

The bank's main concern, inflation, is significantly greater than it was during prior crises, and according to the ECB's most recent predictions, which were released on Thursday, price growth would continue to exceed its 2% target through 2025.

According to the ECB, inflation is anticipated to average 5.3% this year, 2.9% in 2024, and 2.1% in 2025. It should be noted that these estimates were made prior to the present upheaval.

The ECB stated that "the Governing Council is monitoring current market tensions closely and stands ready to respond as necessary to preserve price stability and financial stability in the euro area."

While prolonged recessions frequently result from systemic banking crises, the financial sector in the euro zone is in better form than it has been in years, with strong levels of capital, liquidity, and profits.

Other analysts however asserted that the ECB had a variety of tools at its disposal to combat market stress and had not required to forgo the rate hike in order to maintain the buoyancy of financial assets.

Market focus now shifts to ECB President Christine Lagarde's press conference, where she will face questions about upcoming policy changes and the possibility of a banking sector contagion.

She will make an effort to assuage investors' concerns about the stability of the banks in the bloc and reassure them that a variety of ECB liquidity facilities are still available in the event of a crisis.

She may, however, refrain from proposing any specific actions to assist banks, particularly in light of the ECB's recent subsidy removal from a significant long-term lending instrument in an effort to wean lenders off of central bank funds.

By fLEXI tEAM