FRANKFURT (Reuters) – European Central Bank policymakers are meeting on Thursday amidst turmoil in financial markets that could force it to divert from plans for another hefty interest rate hike even though inflation remains too high.
After embarking on a campaign to curb price growth that has seen it raise rates since July at its fastest pace on record, the ECB had been set for another 50 basis point increase on Thursday.
But the collapse last week of Silicon Valley Bank in the United States has raised concerns about stresses across the banking sector and caused shares to plunge, with Credit Suisse, long dogged by problems, at the centre of the rout in Europe.
Now the ECB must reconcile its inflation-fighting credibility with the need to maintain financial stability in the face of overwhelmingly imported turmoil.
Complicating its task, the central bank for the 20 countries that use the euro currency has essentially already committed to a 50 basis point increase on Thursday.
“Unless the ECB sees the inflation outlook significantly different than one week ago, anything but a 50 basis point move would be a big mistake and hurt credibility,” Danske Bank economist Piet Haines Christiansen said.
Euro zone inflation was 8.5% in February, below its peaks of last autumn but way above the ECB’s 2% target, and the outlook is likely to remain grim.
Although forecasts for headline inflation will be cut due to the fall in energy prices, the new figures will continue to show price growth significantly above the target in 2024 and slightly over in 2025, a source with direct knowledge told Reuters.
Meanwhile projections for underlying inflation, an indicator of the durability of price growth, are set to be raised, suggesting that disinflation will be protracted and monetary policy will have to remain tight for some time.
This outlook is so worrying that prior to the turmoil in the banking sector, which could derail the ECB’s strategy and the whole economy, a long list of policymakers had advocated rate hikes continuing beyond March.
COLD FEET?
Markets are nevertheless doubting the ECB’s resolve and have dialled back bets on the size of Thursday’s move and subsequent rate hikes. Money market pricing suggests that investors now see just a 30% chance of a 50 basis point increase, down from as high as 90% early on Wednesday.
“Central Banks should not ignore the signs from the markets and the more likely recession forthcoming,” former ECB Vice President Vitor Constancio said. “They should tone down their hiking campaign. The ECB should do at most 25 bps and not the announced 50 bps.”
The peak ECB rate, also known as terminal rate, is now seen at only around 3.25%, down from 4.1% last week, an exceptional reversal in market pricing.
Hoping to prop up confidence, the Swiss National Bank said late on Wednesday that it was ready to provide Credit Suisse with liquidity, if necessary, though the bank met all capital and liquidity requirements.
“Clearly there is a strong case for the ECB to wait and see how things develop,” Andrew Kenningham at Capital Economics said. “But our best guess at this stage is that the bank will press on with its pre-announced plan to raise the deposit rate from 2.5% to 3.0%, while stressing that policy is not on a predetermined path.”
Even if the ECB goes ahead with the 50 basis point hike, it is almost certain to move away from its recent practice of signalling its next step and will leave the door open regarding the May meeting, even if a bias for higher rates remains.
ECB President Christine Lagarde will almost certainly try to reassure investors on the health of the bloc’s banks, arguing that they are better capitalised, more profitable and more liquid than during previous periods of turmoil.
But the ECB is likely to stop short of offering specific measures to help banks, especially since it has just removed a subsidy from a key liquidity facility in an attempt to wean lenders off central bank cash.
Lagarde could nevertheless signal that the ECB is ready to step in should contagion start impairing the health of euro zone lenders, and thus preventing the ECB’s monetary policy from being deployed effectively.
“The ECB will be minded to stick to the separation principle: gearing the monetary policy stance towards achieving the inflation aim; and using other tools to deal with financial stability,” BNP Paribas (OTC:BNPQY) said. “Indeed, interest rates are probably the wrong tool to address a liquidity problem.
Source: Economy - investing.com
