A sign for the European Central Bank (ECB) in front of the bank’s headquarters in Frankfurt, Germany, on Thursday, February 2, 2023.
Alexander Kraus Bloomberg | Getty Images
European Central Bank policymakers are reconsidering the trajectory of rate hikes amid last month’s banking turmoil, but remain committed to containing core inflation.
Contagion fears sparked by the collapse of US-based Silicon Valley Bank in early March led to the downfall of several other regional lenders in the US, culminating in the emergency bailout of Credit Suisse by Swiss giant UBS in Europe.
Although the panic at the time prompted a flight of investors and depositors from the global banking sector, the market has since calmed down, with the consensus that the bank failures were the result of idiosyncratic weaknesses in business models rather than a systemic problem.
The ECB hiked rates by 50 basis points in mid-March at the height of the banking turmoil, despite some calls for the central bank to take a break.
This week, however, several ECB Governing Council members highlighted the risk of a knock-on effect on the economy as interest rates continue to rise in a bid to fight inflation.
Eurozone headline inflation fell sharply to 6.9% yoy in March, mainly due to falling energy prices. However, 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 caused some ECB politicians – such as the Austrian National Bank Governor Robert Holzmann – to rethink their position.
He had previously hinted that the Governing Council may have to consider up to four more rate hikes, starting with a 50 basis point hike 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 take a closer look at the situation after the next meeting.
“Clearly what we saw with the banking crisis in the US and with Switzerland changed the outlook and when the outlook changes we have to change our views,” Holzmann told CNBC’s Joumanna Bercetche at the spring meeting of the IMF in Washington. direct current
He added that ongoing core inflation still needs to be taken into account, but it is “not the only part” that matters as financial conditions tighten noticeably and access to credit for households and businesses decreases.
“What also matters is the situation on the financial markets. If the situation on the financial markets strengthens, it becomes more difficult for households and companies to take out credit, this must be taken into account. At what time [rates must rise] depends a lot on what the environment is telling us at the time.”
This cautious tone was echoed by Ignazio Visco, another member of the Governing Council.
The Bank of Italy governor said the financial turmoil – although still being felt in the euro zone, where banks are largely well capitalized and have ample liquidity – is one of several factors increasing downside risk to the economic outlook.
“The Italian banking sector is doing well, the European banking sector is doing well, in terms of the turmoil that we’ve seen – it’s mainly related to the business models of the banks affected,” Visco said.
“It’s a quirk, but there could be contagion for other reasons. Social media works in a way that is very difficult for us to understand right now.”
Concerns about core inflation
Visco called for patience when assessing the course of the ECB’s interest rate hikes, especially since credit conditions had “tightened considerably”. However, he said policymakers will be examining the data for signs that core inflation is decelerating and that the bank’s medium-term inflation target of 2% is within sight.
“If you look at the credit data, it actually shows that the growth rate has dropped from over 10% in late summer to zero and is now negative in real terms, so we’re tightening. We’ll have to wait for the delays that monetary policy will bring,” he said, suggesting that it could take anywhere from a year to 18 months for the latest policy measures to hit the euro-zone economy.
Other Governing Council members agreed that core inflation is a key metric for the ECB to use in determining the pace of rate hikes and the stage at which it can afford to come off the brakes.
Gediminas Šimkus, Chairman of the Bank of Lithuania, said the toughness of core inflation was worrying and indicated it may not have peaked yet. However, he stressed the importance of assessing the lagged impact of existing monetary tightening as it impacts the economy.
“A lot of what we have done is not yet visible. … I believe that we will see core inflation fall before the end of this year. But after all that, I would say that the tight labor market, the active labor market, it adds its additional components to this overall picture…Headline inflation is falling, but service inflation, non-energy industrial goods inflation, they keep rising,” Šimkus said.
“A lot of people ask what is … the final rate? But our decisions are made on the basis of various data, macroeconomic forecasts, in-depth financial and economic data, it’s not just about the inflation figure… It’s all about the data set that makes up the decision.”
Edward Scicluna, Governor of the Central Bank of Malta, also said that the ECB “still has work to do” in dealing with price hikes.
“We can’t do anything about energy prices, but we’re very upset that inflation is starting to resolve, that wage earners would say, ‘Oh, we don’t think it’s going down, so we’re going to demand wage increases.’ The same applies to companies. So yes, we are concerned that core inflation has not yet peaked,” Scicluna said.
He added that the magnitude of future rate hikes will be difficult to predict given economic developments, including concerns about the banking system, but indicated that the fact that discussions of a pause or slowdown are taking place is an indication that the interest rates are approaching their peak.
“It gets harder every time. It’s a good sign that the end of the tunnel isn’t that far,” he said.
“Not over the hill yet”
Although the eurozone economy has so far avoided a recession, concerns remain about the impact on growth of further monetary tightening.
Bank of Latvia Governor Mārtiņš Kazāks underlined this on Thursday, noting that the 20-strong bloc is “clearly not over the hill” and that the risk of a recession is “non-trivial”.
“Inflation is still high. There is a risk of some financial instability – so far so good in Europe and there is reason for optimism but we need to keep an eye on the situation,” he told CNBC.
“But we also see that labor markets have been very strong, much stronger than expected, which means rates need to rise more sharply to tame the inflation problem, and that may have some implications for the vulnerabilities that we also see in certain segments of the market.” have seen.”
Asked how to balance the need to control inflation with the risk of excessive tightening and further downward pressure on growth, Kazāks urged policymakers to remain focused on the inflationary mandate, saying he saw “no reason”. to brake in the foreseeable future”.
“The risk of not doing enough in raising interest rates is significantly higher than doing too much, in my view,” he said.
Correction: This article has been updated with the latest comments from Gediminas Šimkus, Chairman of the Bank of Lithuania. A previous version contained outdated comments.
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