ECB policymakers are reconsidering rate hikes after banking turmoil
A sign for the European Central Bank (ECB) outside the bank’s headquarters in Frankfurt, Germany, on Thursday, February 2, 2023.
Alex Kraus | Bloomberg | Getty Images
European Central Bank policymakers are reconsidering the path of interest rate hikes in the wake of last month’s banking turmoil, but remain committed to maintaining core inflation.
Fears of contagion from the collapse of US-based Silicon Valley Bank in early March led to the collapse of several other regional lenders stateside, culminating in the emergency rescue of Credit Suisse by fellow Swiss UBS in Europe .
While investors and investors from the global banking sector panicked at the time, the market has since calmed amid a consensus that the bank failures were the result of unusual weaknesses in business models , rather than a systemic issue.
The ECB increased rates by 50 basis points in mid-March at the height of the banking crisis, despite some calls for the central bank to hold off.
But this week, several members of the Governing Council noted that there is a risk of an economic impact as interest rates continue to rise in an attempt to deal with inflation.
Headline inflation in the euro zone fell sharply in March to 6.9% annualized, largely due to a fall in energy prices. But core inflation – which excludes volatile energy, food, alcohol and tobacco prices – rose to an all-time high of 5.7%.
The events of the past month have made some ECB policymakers – such as Austrian National Bank Governor Robert Holzmann – reconsider.
He had previously suggested that the ECB’s Governing Council might have to consider up to four more rate hikes, starting with a 50 basis point increase at its next meeting in May.
But he told CNBC on Thursday that “things have changed” since those comments two months ago, and that the central bank will need to assess the situation more closely beyond the next meeting.
“Certainly what we experienced with the bank crisis in the US and with Switzerland, this led to changes in the perspective and if the perspective changes, we have to change our views,” Holzmann told Joumanna Bercetche at CNBC at the IMF Spring Meetings in Washington, DC
He said the persistence of core inflation must be taken into account, but it is not “the only part” that is important, with financial conditions tightening in particular and access to credit reducing for households and businesses.
“What is also important is the situation in the financial markets. If the situation in the financial markets increases, more difficult for families and enterprises to take credit, this must be taken into account. [rates must rise] it really depends on what the environment is telling us at the moment.”
This cautious tone was echoed by another member of the Governing Council Ignazio Visco.
The Bank of Italy governor said financial turmoil – although not yet felt in the euro area, where banks are mostly well capitalized and with sufficient liquidity – was one of several factors that put lower risk to the economic outlook.
“The Italian banking sector is doing OK, the European banking sector is doing OK, in terms of the disruption we’ve seen – it’s mostly related to the business models of the specific banks affected by this,” said Visco.
“This is unfortunate, but there may be contagion for other reasons. Social media works in ways that are very difficult for us to understand now.”
Key inflation concerns
Visco called for patience in assessing the ECB’s rate hike path, especially as credit conditions are “significantly tightened.” But he said policymakers will be examining the data for signs that core inflation is easing and the bank’s medium-term inflation target of 2% is in sight.
“As a matter of fact, if you look at credit data, they show that the growth rate has gone from over 10% at the end of the summer to zero, and negative in real terms now, and as that’s what we’re trying to do. We have to wait for the delay that monetary policy takes,” he said, suggesting that it would take between a year and 18 months for recent policy moves to pass through to the euro zone economy.
Other members of the ECB’s Governing Council were unanimous in identifying core inflation as a key metric for the ECB in determining the pace of rate hikes, and the rate at which it could come off the brakes.
Gediminas Šimkus, chairman of the Bank of Lithuania, said the stability of core inflation was a cause for concern, and suggested that it may not have peaked yet. However, he emphasized the importance of assessing the ripple effect of policy tightening as it permeates the economy.
“A lot of what we’ve done, it’s yet to be seen. … I believe we’ll see core inflation go down even this year. But having said all this, I would say to the labor market is tight, the labor market is active, it’s adding its own components to this overall picture… Core inflation is going down, but service inflation, non-energy industrial goods inflation, is continuing rising,” said Šimkus.
“A lot of people are asking what is … the level of completion? But our decisions are made according to various data, macroeconomic projections, financial and economic data that come in, not just about the inflation number … a data set, which is a conclusion.”
Edward Scicluna, the governor of the Central Bank of Malta, also said that there is still “a way to go” for the ECB in the fight against price increases.
“We can’t do anything about energy prices but we are very upset to see that inflation is starting to kill it, that wage earners would say ‘oh we don’t believe that it is coming down so we will ask for a salary increase.” So yes, we are concerned about core inflation which has not yet peaked,” said Scicluna.
He said the size of any future rate hikes will be difficult to predict given economic developments, including concerns about the banking system, but suggested that discussions about a pause or delay taking place is a sign that policy rates are close to their maximum.
“It gets harder every time. That’s a good sign that the end of the tunnel is not that far,” he said.
‘Not out of the woods yet’
Although the euro zone economy has so far avoided recession, there have been concerns about the impact on growth of further monetary policy tightening.
Bank of Latvia Governor Mārtiņš Kazāks pointed this out on Thursday, noting that the 20-member bloc is “clearly not out of the woods yet” and that the risk of recession is “non-negligible”. “
“Inflation is still high. There are risks of some financial instability – so far, so good in Europe, and there is some reason to be confident about it, but we have to follow the situation,” he told CNBC.
“But we also see that the labor markets have been very strong, much stronger than expected, which leads to a situation where the rates have to go up more to solve the problem of inflation harassment, and that could affect the pockets of vulnerability. which we have seen in some market segments play out as well.”
Asked about balancing the need to control inflation with the risk of overshooting and putting further pressure on growth, Kazaks urged policymakers to stay focused on the inflation mandate, and said he saw “no reason to slow down any time soon.”
“The risk of not doing enough in terms of raising rates, in my opinion, is much higher than doing too much,” he said.
Correction: This article has been updated with the latest comments from Gediminas Šimkus, chairman of the Bank of Lithuania. An earlier version contained outdated comments.