16 MAR, 2023
By Constanza Ramos
The ECB has decided to stay the course despite the instability shaking the financial markets following the collapse of Silicon Valley Bank and Signature Bank, as well as the ongoing crisis at Credit Suisse. The European Central Bank raised rates by 0.5 percentage points to 3.5%. This is the sixth consecutive increase in the price of money. However, the ECB has warned that it is prepared to "inject liquidity into the eurozone financial system if necessary".
Below, we leave you with the first reactions from fund industry experts following Christine Lagarde's appearance.
ECB President Lagarde today firmly stated that there is no dilemma between her financial stability and monetary policy objectives. However, with underlying inflation pressures still red-hot on the continent, her lack of guidance on future rate hikes suggests that not everyone on the governing council agrees with her. The market has been quick to discount many future rate hikes and even discount the possibility of cuts in the second half of the year.
The reality is that markets have already seen signs of banking stress, and anyone who has suffered the effects of the global financial crisis will not be easily convinced that all is well by what policymakers say, who are often responsible for the liquidity extremes that cause many of these problems in the first instance. Now that the toothpaste against bank stress is out of the tube, it's not going to be so easy to put it back in.
The European Central Bank has raised its interest rates again today to take the deposit rate to 3%, the highest level since 2008. In total, interest rates have risen three and a half points from last summer's low as part of the ECB's fight against inflation. The European monetary authority has not changed the pace of quantitative tightening (QT) and, in its statement, did not anticipate further rate hikes. Economic forecasts have changed, as expected. Inflation has been revised downward and economic growth upward, based on lower-than-expected energy prices, the effects of which will be felt soon. During the press conference, President Lagarde acknowledged that the outlook is now more uncertain, following the recent volatility in financial markets. However, she stressed that the banking sector is in a much stronger position than in previous crises and that the ECB has many tools at its disposal to deal with any stress or even a liquidity crisis, if necessary.
Markets are now wondering whether Eurozone interest rates are close to their peak, as opposed to a few weeks ago when rates were expected to rise above 4.0%. Given the levels of volatility in the market, it seems likely that the pace of hikes, if any, will be slower than previously anticipated, despite robust inflation data.
ECB hikes rates by 50 basis points but offers no further guidance on future interest rate paths. The European Central Bank (ECB) has kept its promise and raised policy rates by another 50 basis points, despite tensions in financial markets. This is good news in the context of persistently high inflation rates. At the same time, it reaffirms its intention to intervene with liquidity measures if the stability of financial markets is threatened. ECB President Lagarde repeated several times that various options were available, with the clear intention of calming the markets.
For the first time, the central bank refrained from committing itself to the future path of interest rates. Thus, the ECB remains totally data-dependent. This data includes not only the inflation outlook and the dynamics of the underlying inflation trend but also the strength of the monetary transmission. In an environment of high uncertainty, this is understandable. However, it remains questionable to what extent the further development of financial market stability limits the ECB's options. In his view, there is no trade-off between price stability and financial market stability. But ultimately, the central bank must set its priorities. The ECB's mandate is price stability. This is not the case either at present or on the basis of forecasts for the coming years. Therefore, it is likely that the ECB will not be able to avoid raising policy rates further.
Despite the turbulence in the markets in recent days, the ECB decided to stay the course at its March meeting by proceeding with the pre-announced 50 basis point hike. In doing so, it wanted to clearly show its confidence in its ability to address financial stability issues with the appropriate instruments, without taking its eyes off the objective of price stability. In its statement, the ECB also abandoned forward guidance, now stressing the importance of data dependence and signaling its readiness to "respond as needed" to preserve price stability and financial stability in the euro area.
It remains to be seen whether this strategy succeeds in restoring calm to markets and is sufficient to deal with any further contagion effects. By committing to this hike almost unconditionally, the ECB had put itself in an extremely difficult situation, unnecessarily in our view, leaving little room for maneuvering in the event of a shock. What is now clear to us is that the problems in the banking sector, although concentrated in what may well be idiosyncratic stories in themselves, are nonetheless a symptom of the much tighter policy environment engineered by central banks in recent months. In our view, the degree of policy tightening by the ECB and Fed to date has already been sufficient to trigger a hard landing. Both need to proceed with extreme caution from now on, with flexibility and open-mindedness.
The latest ECB bank lending survey for Q1 2023 already showed a significant tightening of credit conditions and lower loan demand. We now expect the vulnerabilities in the banking sector that have surfaced to have a direct impact on banks' willingness to lend, leading to even tighter funding conditions which, in turn, would hit the real economy potentially sooner and harder than expected. In this sense, further rate hikes from now on would likely constitute a policy mistake that would ultimately require a swift course correction in the coming months. Going forward, we will keep a close eye on bank CDS, as they are now the leading indicator of tightening financing conditions.
The decision to raise interest rates by 50 basis points, as anticipated, was communicated amid a banking drama surrounding Credit Suisse and just days after the collapse of Silicon Valley Bank rattled financial markets. The ECB was right to hold the line and not reduce the size of the increase it had already announced. Otherwise, it would have sent a panic signal to the markets and could have triggered even more turbulence. Moreover, with a year-on-year inflation rate of 8.5% and a core inflation rate of 5.6% trending upwards, it would have taken a step backward in the process of cementing its credibility.
The rise in interest rates is doing what was expected: bringing out those investments that were only profitable under the shadow of near-zero interest rates. The collapse of FTX and the UK pension fund scare a few months ago are examples of investments hidden beneath the free money waters that came to the surface with higher rates. So far the European banking sector in general seems to be in good health, but we do not know which investments in which other sectors could start to falter. However, this cleansing process in the markets will allow for a more efficient allocation of capital.
Lagarde's message maintained the dichotomy of past press conferences. On the one hand, she emphasized the ECB's commitment to reach the 2% inflation target, and on the other hand, she noted that reaching it will depend on what we see in the data. What the Federal Reserve decides next week, the development of wages and services prices in the euro area, as well as the growth momentum from China's reopening will set the stage for the ECB's next decision.
By RankiaPro Europe
By RankiaPro Europe