The European Central Bank (ECB) raised interest rates by 0.5 percentage point on Thursday, despite the unrest in the banking sector in recent days. The ECB does say it is ready to provide extra liquidity to European banks in case of emergency.
This is according to a statement which the ECB board released on Thursday afternoon. ECB President Christine Lagarde will give a press conference this afternoon at 2:45 p.m. (here to follow).
The ECB faced a dilemma on Thursday. On the one hand, inflation in the eurozone remains stubbornly high: 8.5 percent on an annual basis in February. The ECB aims for an inflation rate of 2 percent. Interest rate hikes are the classic means for central banks to combat inflation: borrowing becomes less attractive when interest rates are high, which slows down the economy. Ultimately, this should also reduce inflation.
On the other hand, higher interest rates have put parts of the banking sector in trouble. The American Silicon Valley Bank collapsed last week because of the plummeted value of government bonds – a result of interest rate hikes by the US central bank, the Federal Reserve. The unrest spread to Europe this week, especially to the long-troubled Swiss bank Credit Suisse, which is now being provided with emergency credit by the Swiss central bank. Banks in the eurozone are also under pressure. Heavy price losses of major banks such as ING, Deutsche Bank and BNP Paribas on Wednesday were barely made up on Thursday.
Fighting inflation comes first
Despite this unrest, the ECB is focusing on fighting inflation. “Inflation is expected to remain too high for too long,” the statement said. The deposit rate for banks at the ECB will go from 2.5 to 3 percent, the standard interest rate at which banks borrow from the ECB from 3 to 3.5 percent. The increased uncertainty in the financial sector does force vigilance, says the board: “The Governing Council is closely monitoring the current tensions in the market and stands ready to react if necessary to maintain price and financial stability in the euro area .”
According to the ECB, the banking sector in the euro area is “shock resistant, with strong capital and liquidity positions”. The ECB’s policy instruments are “fully equipped to provide liquidity support to the euro area financial system when needed,” said the ECB’s Governing Council.
Not a new tool
The ECB is not introducing a new tool to assist banks in distress, as the Fed did on Sunday. The Fed’s Bank Term Funding Program (BTFP) must ensure that they always have enough liquidity to pay customers. If American banks are in financial distress, they can borrow on favorable terms.
The ECB is committed to phasing out the mountain of government and corporate bonds (around EUR 5,000 billion) that it has been buying since 2015. Letting this stock shrink keeps interest rates on the capital market high.
Read also: Confidence in banks is falling, inflation may rise: the consequences of the SVB debacle