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ECB sticks to rate hike plan despite banking turmoil

The European Central Bank has raised its main interest rate by a further 0.50 percentage points to 3.5 per cent, the bank’s governing council has decided.

March 17, 2023
17 March 2023

The European Central Bank has raised interest rates by 50 basis points as promised to curb inflation, ignoring financial market chaos and calls by investors to dial back policy tightening at least until sentiment stabilises.

The ECB has been raising rates at its fastest pace on record but a rout in global markets since the collapse of Silicon Valley Bank (SVB) in the United States last week had threatened to up-end those plans at the last moment.

In line with its often-repeated guidance, the central bank for the 20 countries that share the euro lifted its deposit rate to 3.0 per cent, the highest level since late 2008, as inflation is seen overshooting its 2.0 per cent target through 2025.

“Inflation is projected to remain too high for too long,” ECB president Christine Lagarde told a news conference, reading from the statement agreed by the bank’s policymakers.

“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,” she said, while adding that the region’s banks had strong capital and liquidity positions.

The statement offered no commitments for the future despite previous calls by a long list of policy makers for more big moves in the fight against inflation.

“We know that if our baseline were to persist when the uncertainty reduces, then we have a lot more ground to cover,” Lagarde said.

“But it’s a big caveat, ‘if our baseline was to persist’,” she added, noting that it was currently impossible to determine the future path of interest rates amid “completely elevated” uncertainty stemming from the market ructions.

The euro and bond yields edged up after the move. 

Earlier, after days of turmoil in markets, financial investors had seen a 50 per cent chance of a smaller 25 basis point move by the ECB and dialled down expectations for future moves.

Lagarde emphasised that the banking sector as a whole was in a “much, much stronger position” than it was at the point of the 2008 financial crisis. 

Euro zone bank shares nonetheless hit two-month lows after the rate move before partially recovering.

Those bank shares had been in freefall this week, spooked first by SVB’s collapse then a plunge in the value of Credit Suisse – a lender that has long been dogged by problems.

But the Swiss National Bank threw Credit Suisse a $US54 billion ($A81 billion) lifeline overnight, a big enough show of force to send its shares back up about 20 per cent and lift other bank stocks.

The key worry for the ECB is that monetary policy works via the banking system, and a full blown financial crisis would make its policy ineffective.

That left the ECB in a dilemma, pitting its inflation-fighting mandate against the need to maintain financial stability in the face of overwhelmingly imported turmoil.

ECB vice-president Luis de Guindos said euro zone exposure to Credit Suisse was “quite limited” and Lagarde noted that in any case, the policy tools the ECB had at its disposal meant there was no trade-off between financial and price stability.

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