The European Central Bank raised interest rates by 50 basis points on Thursday as it had previously promised to curb inflation, ignoring chaos in financial markets and investor calls to curb monetary tightening at least until confidence stabilizes.
The ECB has been raising rates in recent months at the fastest pace in its history, but the collapse of global markets following the collapse of US Silicon Valley Bank (SVB) last week had threatened to derail its currency plans at the last moment.
In line with its repeated guidance, the central bank of the 20 countries that share the euro raised its deposit rate to 3%, the highest level since late 2008, estimating that inflation will exceed its target of 2% until 2025.
“Inflation is expected to remain too high for too long,” ECB President Christine Lagarde told a news conference where she read out the statement agreed by the central bank’s monetary policymakers.
“The Governing Council is closely monitoring ongoing market tensions and stands ready to respond when necessary to preserve price stability and financial stability in the euro area,” Lagarde said, adding that banks in the region have a strong capital and liquidity position.
But the declaration offered no commitment for the future, despite previous calls by a long list of currency leaders for stronger action in the fight against inflation.
“We know that if our baseline holds when uncertainty is reduced, then we have a lot more ground to cover,” Lagarde said.
“But it’s a big warning, ‘if our baseline persists,'” he added, noting that it is currently impossible to determine the future path of interest rates.
The euro and eurozone bond yields rose after the decision. Earlier, after days of turmoil in the markets, money markets reflected a 50% probability of a smaller move than the one adopted on Thursday, of 25 basis points, lowering expectations of future movements.
Eurozone bank stocks have been in free fall this week, spooked first by the fall of SVB and then by the collapse in the value of Credit Suisse (SIX:CSGN), a bank long in trouble.
However, the Swiss National Bank threw a $54 billion lifeline to Credit Suisse overnight, a show of force large enough for its shares to rise again by about 000%, which also pushed those of other banks higher.
The ECB’s main concern is that monetary policy works through the banking system, as a full-blown financial crisis would render its current measures ineffective.
This confronts the ECB with a dilemma, as it pits its commitment to fighting inflation against the need to maintain financial stability in the face of overwhelming turbulence from abroad.
Inflation, the ECB’s main concern, is much higher than in previous crises, with the central bank’s new projections, released on Thursday, pushing price growth above its 2% target through 2025, a primary concern for many of its monetary leaders.
According to the ECB, inflation will average 5.3% this year, 2.9% in 2024 and 2.1% in 2025.
Lagarde noted that economic growth prospects are currently tilted downwards.
While systemic banking crises often lead to deep recessions, the euro area financial system is at its best in years, with healthy levels of capital, liquidity and profits.
Some economists also argued that the ECB has enough instruments to combat market tensions, so it has not needed to sacrifice rate hikes to keep financial assets afloat.
The ECB echoed this statement in its statement on Thursday, in which it noted that its monetary policy instruments are “fully equipped to provide liquidity to the euro area financial system if necessary and preserve the smooth transmission of monetary policy.”