European Central Bank raises rates by half a percentage point

London (CNN) The European Central Bank stuck to its plan to hike interest rates by half a percentage point on Thursday, saying inflation poses a greater threat to the economy than turmoil in the banking sector.

But the ECB said it was closely monitoring “current market tensions” and “stands ready to react if necessary to preserve price stability and financial stability in the euro area”.

The central bank has the tools to respond to a liquidity crisis “but that’s not what we see,” ECB President Christine Lagarde told reporters.

Lagarde and Vice-President Luis de Guindos pointed out that European banks were much more resilient than they were before the global financial crisis, with strong capital and liquidity positions, and no concentration of exposure to Swiss credit (CS).

A “relief” for the markets

Shares of European banks rose on Thursday afternoon, recovering from earlier losses that followed the ECB’s rate hike.

“Some kind of relief this afternoon for the markets after the ECB meeting,” said Christophe Boucher, Chief Investment Officer at ABN AMRO Investment Solutions.

Some analysts had expected the central bank to opt for a more modest 25 basis point hike to balance inflationary pressures and the risk of worsening market tensions, especially after the sharp sell-off in bank stocks on Wednesday and Credit Suisse called on a lifeline from the Swiss Central Bank.

But the markets “remained relatively stable” after the Announcement from the ECB, Boucher said, “which ultimately came as no surprise.”

Lagarde said the decision to raise 50 basis points was made by a “very large majority … and in rather record time.” However, unlike previous meetings, it did not announce any further hikes to come, suggesting that the central bank may now take a break to take stock.

THE The latest news from the ECB This decision brings the reference rate of the 20 countries that use the euro to 3%. The central bank has now raised rates in six straight meetings since July in a bid to keep inflation under control.

“Inflation is likely to stay too high for too long,” the ECB said on Thursday, adding that core inflation – excluding energy and food price volatility – continued to rise in February.

At 8.5%, eurozone inflation last month was well above the central bank’s 2% target. And Wednesday’s data showed a stronger-than-expected increase in industrial production in the euro zone.

“The ECB did today the only thing you would expect from a central bank with a price stability mandate when inflation (…) is more than double the target,” said Sylvain. Broyer, chief European economist at S&P Global Ratings.

“Potential fragilities in the banking system should be addressed by policy instruments other than interest rates. The ECB has many such instruments at its disposal,” he added.

Banking turbulence could weigh on the economy

There are growing fears that the demise of Silicon Valley Bank last week, which rattled banking stocks, could lead banks to take a more cautious approach to lending. This would weigh on economic growth and inflation, reducing the need for rate hikes.

Lagarde acknowledged that “persistently elevated market stress” could further tighten already tightening credit conditions. Growth in loans to households has slowed further since the last ECB meeting, as higher borrowing costs have asked.

A “weakening of bank credit would contribute to weaker price pressures than currently expected,” she added.

Based on projections made in early March before the collapse of SVB, ECB staff now expect inflation to average 5.3% in 2023, which is lower than the 6.3% they forecast in December.

A high level of uncertainty reinforces the importance of being guided by economic data in political decision-making, said Lagarde. She stressed that the ECB’s desire to fight inflation and bring it down to 2% remained “intact”.

Salomon Fiedler, economist at Berenberg, said that ahead of its next meeting in May, “the ECB will have to judge the extent of the tightening of financial conditions in response to recent shocks – and therefore the extent of the economic slowdown and inflation even without further ECB action.”

The Federal Reserve and Bank of England will have to make a similar call when they meet to set interest rates next week.

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