ECB keeps eye firmly on inflation amid banking crisis fears

ECB keeps eye firmly on inflation amid banking crisis fears
Опубликовано: Thursday, 16 March 2023 21:05

Rate hike had been well flagged, but recent market turmoil had meant it was less than certain.

FRANKFURT — The European Central Bank moved to raise interest rates by a half percentage point to 3 percent Thursday, sticking to its previous guidance even as fears of a new financial crisis roiled markets in recent days.

Policymakers opted to prioritize a continued fight against stubbornly high inflation over financial stability concerns, noting that “inflation is projected to remain too high for too long.”

After the collapse of two U.S. banks and turmoil at Swiss banking giant Credit Suisse, worries about a potential banking crisis spooked markets and raised doubts over whether the ECB would keep to its previously signaled rate path.

The decision to stick to the well-flagged rate hike may, though, expose ECB President Christine Lagarde to criticism that she is repeating mistakes made by one of her predecessors, Jean-Claude Trichet, who raised rates into the 2011 sovereign debt crisis arguing that anchoring inflation expectations is the best way to boost confidence in the single currency area. That move has gone down in history as a glaring policy error that scarred the ECB’s credibility for years.

“They will be accused of making an error, and they might, but to be fair, they’ve been accused of that since exiting NIRP [negative interest rate policy],” Pantheon Macroeconomics economist Claus Vistesen tweeted after the announcement.

“We’re mindful of our history and what has been done in the past, but we are all confident that the decision that we made today is a robust decision," Lagarde said at a news conference, adding that "the ECB’s policy toolkit is fully equipped to provide liquidity support to the euro area financial system if needed and to preserve the smooth transmission of monetary policy."

While going ahead with the rate hike, the ECB acknowledged the current uncertainty, and dropped a reference to having to raise interest rates “significantly” further.

But Lagarde cautioned that this should not be read as a sign that the ECB may relent in its battle against inflation: “We are not waning," in the fight against inflation "and we are determined to return inflation back to the 2 percent target in the medium term. That should not be doubted.”

Lagarde noted that interest rates will have to go up further if the economy develops as suggested by latest forecasts — though predictions have been made more difficult by the current uncertainty.

In an additional sign that hawks on the Governing Council continue to dominate the discussion, Lagarde revealed that the “[rate hike] decision was adopted by a very large majority.”

Inflation forecasts

The latest ECB forecasts now see headline inflation coming down faster than previously expected, due mainly to easing energy prices. ECB staff see inflation averaging 5.3 percent in 2023, 2.9 percent in 2024 and 2.1 percent in 2025. At the same time, estimates for underlying inflation pressure were revised up, suggesting prices could prove stickier than previously thought.

However, the ECB stressed that forecasts were concluded before the start of recent market tensions, implying that the baseline is surrounded by exceptional uncertainty.

Ahead of Thursday’s rate move, former dovish ECB policymakers Lorenzo Bini Smaghi and Vítor Constâncio had warned that the central bank must avoid a repeat of the 2011 policy disaster. “The ECB should avoid repeating the 2011 mistake, when it continued hiking rates without taking into account the growing contagion from the Greek debt restructuring,” Bini Smaghi told Germany’s Börsen-Zeitung. In a similar vein, Constâncio tweeted that central banks “should not ignore the signs from the markets.”

To be fair, however, the trade-off now between financial stability and price stability seems far less obvious than it was in 2011 — at least in hindsight: While European banks are in the best shape in years, and not one eurozone bank has yet had to receive support, back in the day, the eurozone started to bail out its third member country.

Today, inflation still runs at more than three times the ECB’s 2 percent target after hitting double digits, while in 2011 inflation barely topped 3 percent.

Another former policymaker, Jörg Asmussen, welcomed the rate move. “The ECB faced a difficult conflict of interest: continuing to fight stubborn inflation, or calming financial markets,” he tweeted. “Since monetary stability is the ECB’s primary goal, and financial stability is secondary, today’s 50 basis point rate move is the right move.”

Some analysts argued that changing tack could have created even more financial stability risks: “Backing off from an already announced rate hike with such short notice risks raising further questions and concerns about the stability of the euro area financial system,” Societe Generale economist Anatoli Annenkov said before Thursday’s move.

Nevertheless, the last few days have been a good reminder to the ECB that the next steps in fighting inflation will be much harder than those taken so far, argued ING economist Carsten Brzeski.

“Every additional rate hike increases the risk of breaking something,” he said. “As a result, we expect the ECB to turn more dovish today and in the coming weeks, probably hinting at a slowdown in the pace and size of any further rate hikes.”

This article has been updated.

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