The European Central Bank raises interest rates by half a percentage point

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

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

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

Lagarde and Vice President Luis de Guindos stressed 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 in Europe’s banks rose on Thursday afternoon, recovering from earlier losses that followed the ECB’s rate hike.

“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 smaller 25-basis-point hike to balance inflationary pressures against the risk of adding further stress to markets, especially after bank stocks sold off sharply on Wednesday and Credit Suisse took a lifeline from Switzerland’s central bank.

But markets “remained relatively stable” after The ECB’s announcement, Boucher said, “ultimately produced no surprises.”

Lagarde said the decision to raise by 50 basis points was made by a “very large majority … and in fairly record time.” But unlike after previous meetings, she did not signal that further increases were to come, suggesting that the central bank may now pause to take stock.

That The ECB’s latest move brings the benchmark interest rate across the 20 countries that use the euro to 3%. The central bank has now raised interest rates at six consecutive meetings since July in an attempt to bring inflation under control.

“Inflation is expected to remain too high for too long,” the ECB said on Thursday, adding that core inflation – excluding volatile energy and food prices – continued to rise in February.

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

“The ECB today did the only thing you could 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 plenty of such instruments at hand,” he added.

Bankruptcy can weigh on the economy

There are growing concerns that the death of Silicon Valley Bank last week, which has hammered banking stocks, could prompt banks to take a more cautious approach to lending. That would weigh on economic growth and inflation and reduce the need for interest rate hikes.

Lagarde acknowledged that “persistently elevated market tensions” could further constrain already tight credit conditions. Lending growth to households had slowed further since the ECB’s last meeting, as higher borrowing costs weighed down demand.

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

Based on projections made in early March before the SVB’s collapse, ECB staff now see average inflation of 5.3% in 2023, down from the 6.3% they expected in December.

A high level of uncertainty reinforces the importance of being guided by economic data when making policy decisions, Lagarde said. She stressed that the ECB’s determination to fight inflation and bring it back to 2% remained “intact”.

Salomon Fiedler, an economist at Berenberg, said that before its next meeting in May, “the ECB will have to assess how much financial conditions tighten in response to recent shocks – and thus how much economic momentum and inflation would slow even without further ECB action.”

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

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