The European Central Bank (ECB) announced on Thursday that it will increase interest rates by half a percentage point, despite concerns about banking sector turmoil. The ECB acknowledged the current market tensions and said it would monitor the situation closely. The central bank added that the euro area banking sector is resilient with strong capital and liquidity positions. The move will take the benchmark rate across the 20 countries that use the euro to 3%. The ECB has now hiked rates at six consecutive meetings since July in an effort to control inflation.
The decision was made even though some analysts expected the ECB to opt for a smaller hike of 25 basis points to balance inflationary pressures against the risk of adding further stress to markets. Furthermore, the demise of Silicon Valley Bank raised concerns about the resilience of other banks, which could lead to a more cautious approach to lending, affecting economic growth and inflation, thereby reducing the need for rate hikes. At 8.5%, inflation in the euro area last month was far above the ECB’s 2% target. Data released Wednesday also showed a stronger than expected increase in industrial production across the 20 countries that use the euro.
The ECB justified its decision by stating that inflation posed a bigger immediate threat to the economy than banking sector turmoil. The ECB expects inflation to remain high for an extended period, and core inflation, excluding volatile energy and food prices, continued to increase in February. The ECB reiterated that its 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.
Some analysts believe the ECB’s decision “is a test of the conundrum facing central banks,” given the uncertainties surrounding the current situation, and central banks will now have to factor in the risk that the situation snowballs into a broader loss of confidence in the banking system and a significant tightening in financial conditions. Attention will now turn to the ECB press conference scheduled for later on Thursday, during which ECB President Christine Lagarde will have to reassure investors that no major euro area bank is in the same situation as Credit Suisse, and that the ECB has their back.
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