ECB rate hike plans clouded by financial turmoil

European Central Bank (ECB) policymakers are slated to meet on Thursday amidst extreme turmoil in financial markets. This could potentially jeopardize the ECB’s plans for yet another hefty interest rate hike, despite inflation levels remaining too high.

The ECB’s struggle for balance

Having raised rates consistently since July at its quickest pace, the central bank had anticipated a 50 basis point increase on Thursday. However, after the collapse of Silicon Valley Bank in the US, the ECB now faces the challenge of maintaining financial stability while upholding its credibility in fighting inflation.

Complicating this further is the evident commitment to a 50 basis point increase that the ECB has already made. As a result, the pressure is mounting, and anything less than this on Thursday could significantly blow the bank’s credibility.

The gloomy economic outlook

Eurozone inflation reached 8.5% in February, beneath the levels of the previous autumn but still well over the ECB’s target of 2%. Furthermore, projections for underlying inflation suggest that disinflation will be prolonged, and monetary policy will have to remain tight for an extended period.

Before the banking sector turbulence, many policymakers had advocated rate hikes continuing beyond March. However, now it is uncertain whether the ECB will maintain its pledge for a 50 basis point increase.

Markets remain skeptical

Despite the ECB’s stance, markets appear doubtful of its commitment to the rate increase, with reduced bets on the size of Thursday’s move and subsequent hikes. A mere 30% chance of a 50 basis point increase is predicted, a decrease from the previous 90%.

Former ECB Vice President Vitor Constancio has recommended toning down the hiking campaign, suggesting a 25 basis point increase at most, in response to the likely forthcoming recession.

What next?

The ECB struggles to balance inflation control and financial stability, particularly amid the turmoil across the banking sector. The best guess is that the bank will press on with its plan to raise the deposit rate from 2.5% to 3% while stressing that the policy is not predetermined.

If the ECB continues with the rate hike, the bank will likely abandon its recent habit of signaling its next step, leaving the future open to interpretation.

Related Facts

• Eurozone inflation reached 8.5% in February, above the ECB’s 2% target
• The ECB had been set for another 50 basis point increase on Thursday
• Money market pricing suggests that investors now see just a 30% chance of the increase
• The peak ECB rate, also known as the terminal rate, is now seen at only around 3.25%, down from 4.1% last week

Key Takeaway

As the ECB takes on the challenge of balancing inflation control and financial stability, it remains uncertain whether the bank will continue to increase the deposit rate from 2.5% to 3%. Market skepticism persists, with investors predicting only a 30% chance of the rate hike.

Conclusion

The ECB is under extreme pressure to maintain its inflation-fighting credibility while considering the current turmoil in the banking sector. Therefore, whether or not the bank will proceed with its plan for a 50 basis point increase remains uncertain.