The European Central Bank (ECB) raised its base interest rate by half a percentage point last week, as it did in December and February, lifting the rate it pays on deposits from banks to 3 percent and the rate it charges banks for loans to 3.5 percent.
Some analysts had wondered if the sudden banking crisis—including the then-looming demise of Credit Suisse, Switzerland’s second-largest commercial bank—would divert the ECB from its previously announced plan to add the half point.
The answer was no.
ECB officials are “monitoring current market tensions closely” and the bank “stands ready to respond as necessary to preserve price stability and financial stability in the euro area,” ECB president Christine Lagarde told a press briefing after the meeting of the bank’s governing council.
Her comment indicated the bank is aware of a potentially crucial weakness wrought by higher interest rates: banks now hold long-term bonds bought when interest rates were at their bottom and that have lost value as interest rates rose.
Bonds’ loss of value was a key factor in the demise of Silicon Valley Bank, which sparked the current global upset in the financial industry.
In a statement, the ECB said the European banking system is “resilient, with strong capital and liquidity positions.”
The statement also pointed to the “transmission protection instrument” the bank created last summer to smooth out “unwarranted, disorderly market dynamics” that could hamper the ECB’s ability to carry out its policies.
“Inflation is projected to remain too high for too long,” Lagarde said, and that the additional increase was necessary to ensure that inflation was pulled back down to the bank’s 2-percent annual target in a “timely” way.
Consumer prices rose in the Eurozone at an annual rate of 8.5 percent in February after peaking at 10.6 percent in October.
“We are seeing some slight improvement [in inflation] in some areas but, frankly, not a lot,” Lagarde added.
ECB economists expect Europe’s inflation to average 5.3 percent this year and still remain somewhat higher than 2 percent in 2025.
Even after the current banking turmoil settles, the ECB has “a lot more ground to cover” in raising rates, Lagarde predicted.
She acknowledged that some on the governing council had wanted to pause the increase to see how the current upheaval will play out.
Lagarde also offered no guidance about future rate bumps; in the recent past, she had laid out plans for a series of rate hikes months in advance.
Instead, she said future rate moves would depend on incoming data, adding that “it’s not possible at this point to determine what the path will be going forward.”
The lack of future guidance persuaded futures markets that the ECB would move to lesser rate hikes if the banking industry’s volatility continued.
As a result, markets are now gambling that the ECB’s deposit rate will top out slightly above the current 3 percent. A week earlier, the money was on a 4-percent peak.
Similarly, some analysts have speculated that the U.S. Federal Reserve might defer a further increase, or at least shrink its size, until the result of the banking crisis becomes more clear.
The ECB will raise its rate again by a quarter point at each of its next two meetings, Commerzbank Jorg Kramer predicted in a research note.
That would raise the deposit rate to 3.5 percent, less than the 4 percent analysts had foreseen prior to last week.
Markets’ current spasm could “dampen bank lending and thus growth and, ultimately, inflation,” he wrote.
The ECB also is counting on weakness in energy prices to lower inflation back toward its 2-percent target.
TRENDPOST: Europe’s economy is still wobbling and the wobble will worsen.
In February, business bankruptcies numbered the most since at least 2015, as we noted in “Europe’s Business Bankruptcies Climb to Eight-Year High”(21 Feb 2023).
Also last month, both France and Germany reported growth in business activity. (See “European Business Activity Alive and Well?” 28 Feb 2023).
However, the current banking crisis, coupled with the ECB’s newest interest rate boost, will not help Europe’s economy rebound from the COVID aftermath.
While there will be a slight boost as the warm weather boosts the tourist season, the region’s economic trend still points downward.