ECB continues tightening despite financial risks

The European Central Bank tightened monetary policy at its meeting today (March 16) despite growing financial turmoil in the banking sector.

The ECB’s governing council again increased interest rates by 50 basis points, taking the key deposit rate to 3%. The deposit rate was at -0.5% as recently as July, before the ECB began its sharpest tightening cycle since the euro’s creation.

“Inflation is projected to remain too high for too long” to maintain the policy tightening unchanged, the governing council said in its policy statement.

In February, eurozone year-on-year headline inflation declined modestly to 8.5% from 8.6% in January. But the core index, excluding energy, food, alcohol and tobacco, rose to a new record high of 5.6% from 5.3%.

“We are not waning on our commitment to fight inflation,” said ECB president Christine Lagarde in the press conference following the meeting. “We are determined to bring inflation back to the 2% target over the medium term. That should not be doubted.”

Many US analysts now assume the Federal Reserve will slow down interest rate increases at its meeting on March 22 following Silicon Valley Bank’s collapse. By contrast, Lagarde said several times she currently sees no trade-off between price stability and financial stability for the ECB.

Nonetheless, in contrast to previous statements the governing council shied away from signalling its commitment to any additional rate increase.

“Today, forward guidance ended for good,” says Frederik Ducrozet, head of macro research at Pictet Wealth Management. “To be fair, we expected it to happen even before the SVB’s debacle. Faced with this level of uncertainty, there’s no point anymore in committing to future decisions.”

Lagarde said the ECB will use a data-dependent approach to future meetings. The language echoes several recent speeches by the ECB’s chief economist Philip Lane.

Despite its hawkish tone, the policy statement does acknowledge financial stability concerns are becoming more pressing. “The governing council is monitoring current market tensions closely and stands ready to respond as necessary to preserve price stability and financial stability in the euro area,” it says.

The ECB says the eurozone banking sector is “resilient” due to a “strong capital and liquidity positions”. It said it has the tools to “provide liquidity support to the euro area financial system if needed and to preserve the smooth transmission of monetary policy”.

Ducrozet warned he is not convinced by Lagarde’s refusal of a trade-off between price and financial stability.

“These crises tend to be the catalyst for non-linear spillovers, and a circuit-breaker might be needed at some point,” he said. “But today’s decisions suggest that the ECB would not hesitate to intervene, quickly and boldly, if financial stability were to be threatened.”

Higher core inflation

The ECB updated its macroeconomic projections, lowering headline inflation through the projection horizon, but also revised up core inflation. “Crucially, inflation is now projected to be very close to target by 2025,” says Ducrozet.

In December projections forecast headline inflation was going to average 6.3% in 2023, 3.4% in 2024 and 2.3% in 2025. The ECB now sees inflation averaging 5.3% this year, 2.9% in 2024 and 2.1% in 2025.

The previous estimate forecast core inflation to decline from 4.2% in 2023 to 2.4% in 2025. Now it is expected to increase to 4.6% this year, declining to 2.5% in 2024 and 2.2% in 2025.

The ECB now estimates eurozone growth of 1.6% in both 2024 and 2025, down from its December forecasts of 1.9% and 1.8% respectively. It nonetheless raised its baseline projection for average economic growth to 1%, up from 0.5%.