The ECB does not change course: rates up by 50 points. “We are attentive to tensions but European banks are solid”
The European Central Bank keeps the bar straight as expected and raises interest rates by 50 basis points. The collapse of Silicon Valley Bank, Signature and the turbulence around Credit Suisse do not affect the path decided by the president Christine Lagarde. General inflation is falling, but core inflation continues to be more persistent than forecasts. The Northern front, led by Germany, the Netherlands, Austria and the Baltics, wins another battle. But the disagreement of central bankers is growing as they ask for more gradualness and caution in the squeezes. In May, if the data permits, the pace could change.
ECB, a courageous choice that requires proof of facts
The process of normalizing Frankfurt’s monetary policy is still long. And against more lasting and sticky price flare-ups than usual, you need to be patient. If it is true that the overall situation is better than the December estimates, especially in terms of economic activity, it is equally true that the persistence of inflation is such as to force the ECB to take further decisive action. Despite the risks of financial instability present in the eurozone, as remarked by Frankfurt officials to European economy ministers on Tuesday, are rising. In particular, as revealed by Bloomberg, during the Ecofin the vice president of the ECB Luis de Guindos would have underlined that the sudden increases in rates could have implications on the portfolios of credit institutions in the euro area. And this is why the Governing Council “closely monitors the tensions underway on the markets and is ready to intervene where necessary to preserve price stability and financial stability in the euro area”. However, as has been remarked, the euro area banking sector is endowed with “good resilience, with solid capital and liquidity positions”. In any case, it is underlined, Frankfurt states that «it has all the necessary tools to provide liquidity to support the euro area financial system, should the need arise, and to preserve the orderly transmission of monetary policy ».
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The basic problem, explains the ECB, is that “inflation should remain too high for too long a period of time”, as explained in the first sentence of the press release. Therefore, it is explained, «the Governing Council decided today to raise the three key ECB interest rates by 50 basis points, in line with its determination to ensure the timely return of inflation to the 2% target on average term”. The high level of uncertainty increases “the importance of an evidence-based approach to the Governing Council’s decisions on key rates, which will be determined by its assessments of the inflation outlook in the light of new economic and financial data, the dynamics of underlying inflation and the intensity of monetary policy transmission”.
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What is worrying are the new price estimates, completed in early March, i.e. before the recent tensions on the financial markets. “These tensions therefore lead to further uncertainty regarding assessments of the baseline scenario for inflation and growth”, explains the ECB. The indications see general inflation averaging 5.3% in 2023, 2.9% in 2024 and 2.1% in 2025. At the same time, however, «the underlying pressures on prices remain intense. Inflation excluding energy and food continued to increase in February” and an average of 4.6% is expected in 2023, a higher level than that anticipated in the December projections”. Subsequently, it is noted, “it should reduce to 2.5% in 2024 and 2.2% in 2025, as the upward pressures deriving from past supply shocks and the reopening of economic activities fade and the more restrictive monetary policy will increasingly slow down demand». A scenario that has allowed the Governing Council to keep the bar straight for March as well.
In other words, the price increases are more important than the fibrillations of euro area banks, which are better supervised than their US counterparts. The justification for the March rate hike was justified by an economic context in which the robustness of economic activity is significant. It is no coincidence that, as Frankfurt explains, «the projections for growth in 2023 have been corrected upwards in the baseline scenario, settling on average at 1.0% due to both the drop in energy prices and the greater resilience of the economy to the difficult international context”. Furthermore, ECB experts expect “growth to increase further to 1.6% in both 2024 and 2025, supported by the strength of the labor market, the improvement in the climate of confidence and the recovery of real incomes”. Those for next year and 2025, however, are lower estimates than those for December.
After the first quarter of 2023, the discussion on what to do for the second and for the rest of the year will begin. Slowing down is one option. Not surprisingly, no indications were given for the next hikes. The Northern front will continue to push for more powerful tightening, citing the single mandate of the ECB, namely the preservation of price stability. But if further vulnerabilities emerge among eurozone lenders, then the side of more cautious central bankers could take over.