The situation in which the committee around ECB President Christine Lagarde had to make a decision was like a dilemma: on the one hand, the high interest rates have recently caused difficulties on the financial markets. However, the ECB did not have a good alternative to a further increase: Postponing the interest rate hike in order to calm the nervous financial markets could have caused even more unrest in the tense situation and fueled speculation as to whether the ECB might already have problems at banks white.
What also arguably supported the ECB’s decision was its ability to maintain its own credibility in continuing its determined fight against high inflation. This high level of inflation is the result of a long-term development: the interest rate was 0.0 percent for years. But with the end of the pandemic, the economy quickly picked up again, which in turn fueled inflation. To counteract this, interest rates were raised.
But there were also factors that exacerbated the situation: high energy prices as a result of the Russian war of aggression against Ukraine and the associated sanctions are strong inflationary drivers. Higher interest rates are fueling turmoil in the financial markets, because more expensive money means that weaknesses in the way banks operate are revealed – as happened with the SVB, which was forced to buy bonds on disadvantageous terms because customers withdrew their money.
Euro banks “resilient and well capitalized”
A circumstance that the ECB had to address in its responsibility for the stability of the financial markets: In the course of announcing the rate hike, ECB boss Lagarde stated that she was ready to help the banks if necessary. A number of instruments are available to strengthen the stability of the financial system and to provide the financial institutions with liquidity. From the ECB President’s point of view, however, the banking sector in the euro zone is “resilient and well capitalised”.
In addition, it was explained that the situation of the banks cannot be compared with that before the financial crisis of 2008 (keyword: Lehman bankruptcy). And indeed the characteristics are different: in 2008 the financial system collapsed under the multitude of bad loans. The trigger for the current turbulence is eroded trust, triggered by fundamentally different problem scenarios at the banks concerned. However, the cases have nothing to do with the situation on the financial markets.
No contagion detected by euro banks
The ECB – which is also responsible for controlling the banks in the euro area – apparently tried to emphasize this on Friday. According to Reuters, at a special meeting of the ECB Banking Supervision Committee, the supervisors did not see the stability of the sector in the euro zone being affected after the recent turmoil. Deposits at the institutes have remained stable, a person familiar with the matter said after the meeting.
At the special meeting, the inspectors did not see any contagion of financial institutions in the euro zone from the recent stock market turbulence. In addition, the supervisors were informed that the risk of the banks regarding the struggling Credit Suisse was insignificant, as Reuters reported, citing an informed person. Credit Suisse shares fell again on Friday despite a multi-billion dollar stimulus package from the Swiss National Bank (SNB).
No signal for further rate hikes
And how does it go on? The markets evidently interpreted the decisions of the ECB as a signal for the end of the rate hike cycle. The ECB itself also left the further course in the fight against inflation open: unlike in December and February, the central bank gave no signal for further interest rate hikes beyond the current meeting. But Lagarde emphasized that he wanted to continue to fight inflation with determination. An important indicator for further decisions is how quickly the higher interest rates affect the economy.
OECD: Central banks should “stay on course”
Meanwhile, the Organization for Economic Co-operation and Development (OECD) on Friday urged central banks to “stay the course” and raise interest rates further despite the turmoil in financial markets. Inflation continues to be the greatest threat to the global economy. At the same time, the OECD is cautious about the development of the global economy. After 3.2 percent growth last year, economic output is only likely to grow by 2.6 percent this year and 2.9 percent next year.
The OECD also announced that this was below the long-term growth trend. But consumer and business sentiment is slowly improving – this “fragile recovery” is due to falling energy and food prices, the easing of pandemic regulations in China and rising business confidence. The “Financial Times” quoted OECD chief economist Alvaro Pereira: Monetary policy must remain restrictive until there are clear signs that inflationary pressure is being permanently reduced.
Fed decides next week
Next week, the US Federal Reserve (Fed) will have to stake its interest rate rate in the shadow of the ongoing banking crisis. A small quarter-point hike is considered likely for Wednesday’s session. The current range is between 4.50 and 4.75 percent. Like the ECB, the Fed is trying to curb inflation with its tighter monetary policy – so far with moderate success. In February, the inflation rate of 6.0 percent was still well above the central bank’s target of 2.0 percent.
The situation in the USA is currently still tense, so after CS in Switzerland, a bank had to be helped there too: In view of liquidity concerns and heavy price losses on the stock exchange, the regional bank First Republic received a total of 30 billion dollars in funding from the largest US money houses including JPMorgan Chase, Citigroup, Bank of America and Wells Fargo. The move is “highly welcomed” and shows the resilience of the banking system, according to the US Treasury and Fed.
