ECB Makes 'Big Step' Despite CS Crisis... Lagarde Says "Banking System Is Strong" (Comprehensive)

The European Central Bank (ECB) continued its big step of raising interest rates by 0.5 percentage points as announced. Despite the emergence of financial system risks due to the collapse of the U.S. Silicon Valley Bank (SVB) and the Credit Suisse (CS) crisis rumors, the ECB emphasized the 'fight against inflation.' Christine Lagarde, President of the ECB, stated, "We will fight inflation firmly," and also hinted at the possibility of further rate hikes. This is expected to have an impact on the future monetary policy path of the U.S. Federal Reserve (Fed), which is set to decide on interest rates next week.

Christine Lagarde, President of the European Central Bank (ECB)
[Photo by Yonhap News]

◆ ECB Continues Big Steps... Emphasizing the Fight Against Inflation

On the 16th (local time), the ECB announced at its monetary policy meeting that it would raise the benchmark interest rate by 0.5 percentage points to 3.5%. Thus, the ECB, which had maintained rates at 0%, has raised the benchmark rate six times since starting with a 0.5% increase in July last year. The deposit rate and marginal lending rate were also raised by 0.5 percentage points each to 3.0% and 3.75%, respectively.

The ECB stated, "Inflation is expected to remain at a high level for a long time, so we decided on today's rate hike to return to the 2% inflation target in a timely manner," adding, "The increased uncertainty shows how important it is to take a data-driven approach to rate decisions." It also added, "The ECB is fully prepared to provide liquidity support to the Eurozone financial system if necessary."

The market was on edge ahead of the ECB's rate decision that day. Since the sudden collapse of SVB on the 10th, followed by the bankruptcy of Signature Bank on the 12th and the liquidity crisis at CS on the 14th, fear surrounding the global financial system has rapidly spread. Earlier concerns that CS's financial soundness issues could lead to capital outflows and cause financial market instability, such as sharp stock price drops, had raised expectations that the ECB might limit its rate hike to 0.25 percentage points, contrary to prior announcements. However, the Swiss financial authorities' decision to inject up to 50 billion Swiss francs (approximately 70.3 trillion KRW) into CS on the same day somewhat eased the panic.

At a press conference, President Lagarde said, "We are monitoring the tension in financial markets," and "We are ready to take all necessary measures to maintain price stability and financial stability in the Eurozone." She also emphasized that the two policy goals of price stability and financial system stability are not conflicting. Furthermore, she mentioned that the current banking system is much stronger compared to the 2008 global financial crisis.

The ECB's big step that day can be interpreted as confidence in the financial system it has strengthened so far, and at the same time, recognition that the fight against inflation is a more urgent task. Looking at Eurozone prices, the core Consumer Price Index (CPI), excluding food and energy, rose 5.6% in February, increasing from 5.3% the previous month. Although the overall CPI inflation rate slowed to 8.5%, it still exceeded market expectations. The inflation fire remains uncontrolled. Additionally, the quick intervention by authorities in various countries seems to have helped extinguish the immediate risk of financial contagion, which also appears to be part of the background.

President Lagarde reaffirmed the fight against inflation, saying, "If the inflation trend continues when uncertainty decreases, we have room for further (rate hikes)." This rate hike level is also what President Lagarde had previously indicated. Since the ECB took its first big step in July last year for the first time in 11 years, it has increased the tightening intensity with two consecutive giant steps (0.75 percentage point increases in the benchmark rate) and has recently continued three big steps in a row.

Jerome Powell, Chairman of the U.S. Federal Reserve (Fed) [Image source=Yonhap News]

◆ No Mention of Future Rate Hike Path... Who's Next, the Fed?

The ECB's big step is expected to complicate the Fed's calculations regarding the future interest rate path. The Wall Street Journal (WSJ) stated, "Central banks still prioritize curbing high and sticky inflation," and "The ECB's decision shows how major central banks, including the U.S. Fed, will respond to market crisis signals triggered by the collapse of two U.S. banks." The ECB's decision that day has been regarded as a gauge for the direction of the Fed's interest rate decision at the Federal Open Market Committee (FOMC) meeting scheduled for March 21-22.

Markets have been paying close attention to whether the rapid rate hikes by the Fed are behind the SVB collapse and whether this will slow the rate hike momentum of central banks worldwide. This is why the market had strongly anticipated a baby step (0.25 percentage point increase) by the ECB that day. Until just a week ago, the big step card was considered off the table for the Fed as well. However, the debate between a rate freeze and a typical 0.25 percentage point hike has been shifting daily.

According to the Chicago Mercantile Exchange (CME) FedWatch tool, as of that afternoon, the federal funds futures market reflected about an 82% probability that the Fed would raise rates by 0.25 percentage points at the March FOMC. This is up from about 54% the previous day. The probability of a rate freeze, which had risen to the mid-40% range the day before, dropped to 18% as the CS crisis was mitigated by authorities' intervention. The big step forecast has been at 0% since the SVB collapse.

In particular, the market is closely watching the dot plot and other materials the Fed will release immediately after the March FOMC. As the Fed faces the challenge of stabilizing financial risks, many investors expect that it will be difficult to continue high-intensity tightening, and thus the terminal rate is unlikely to exceed 5%. This is below the median year-end rate forecast of 5.1% presented in the Fed's December dot plot. Earlier, Fed Chair Jerome Powell had warned that the terminal rate could be higher than previously expected due to inflation and other indicators exceeding forecasts.

Some experts noted that the ECB did not specifically mention the pace of future rate hikes, suggesting that the Fed and other central banks might slow the pace of tightening. Rohan Kanna, interest rate strategist at Swiss investment bank UBS, said, "They are in a difficult position balancing monetary policy and financial stability," and "Despite rising core inflation, the ECB did not mention the pace of future rate hikes due to financial system instability." He added, "Some may interpret this as a signal that the Fed could be less 'hawkish' at next week's meeting."

Meanwhile, U.S. Treasury Secretary Janet Yellen reiterated the soundness of the U.S. financial system in her opening remarks at the Senate Finance Committee hearing that day. She said, "I reaffirm that our banking system is sound," and "Americans can be confident that they can withdraw their deposits when needed." Regarding SVB, she explained, "There was a liquidity crisis in the current situation," and "We will thoroughly investigate what happened at the bank and why these problems occurred. The bank was closed because it could not handle withdrawals."

This content was produced with the assistance of AI translation services.