The logo of the European Central Bank (ECB) outside the Bank’s headquarters in Frankfurt, Germany, Thursday, February 2, 2023.
Alex Krause | Bloomberg | Getty Images
European Central Bank policymakers are reconsidering the path of rate hikes in light of last month’s banking turmoil, but remain committed to keeping core inflation in check.
Fear spread over the collapse of US-based Silicon Valley Bank in early March, leading to the collapse of several other regional US banks and eventually leading to a bailout of Credit Suisse by European Swiss giant UBS.
While the panic at the time caused investors and savers to flee the global banking sector, markets have calmed down because of the consensus that bank failures were the result of idiosyncratic weaknesses in business models, rather than systemic problems.
The European Central Bank raised interest rates by 50 basis points in mid-March at the height of the banking turmoil, despite calls for the central bank to pause.
This week, however, several members of the governing council noted that there could be knock-on effects on the economy as interest rates continue to rise to combat inflation.
Headline inflation in the euro zone fell sharply to an annual rate of 6.9% in March, largely due to lower energy prices. However, core inflation — which excludes volatile energy, food, alcohol and tobacco prices — rose to a record high of 5.7%.
Events over the past month have some ECB policymakers, such as Austrian National Bank President Robert Holzmann, rethinking.
He has previously said the ECB’s Governing Council may need to consider as many as four further rate hikes, starting with a 50 basis point hike at its next meeting in May.
But he told CNBC on Thursday that “circumstances have changed” since those comments were made two months ago and that the central bank will need to assess the situation more closely after its next meeting.
“It’s clear that what we’ve been through with the banking crisis in the U.S. and Switzerland has led to a change in outlook, and if the outlook changes, we have to change our view,” Holzmann told CNBC’s Joumanna Bercetche at the IMF’s spring meeting in Washington. “DC
He added that the persistence of core inflation still had to be considered, but it was “not the only part that matters”, with financial conditions tightening markedly and households and businesses having less access to credit.
“Equally important is what’s going on in the financial markets. If things stabilize in the financial markets, it becomes more difficult for households and businesses to get credit, and that needs to be factored in. (Rates have to go up) How much depends on the environment at the time tells us a lot of things .”
The cautious tone was echoed by management board member Ignazio Visco.
The governor of the Bank of Italy said that financial turmoil is one of several factors increasing the downside risks to the economic outlook, and although banks in the euro area are mostly well capitalized and have sufficient liquidity, they have not yet felt the financial turmoil.
“In terms of the turbulence we’ve seen, Italian banks have done well, European banks have done well — it’s mostly about the business models of the particular banks affected,” Visco said.
“It’s a trait, but it can be contagious for other reasons. The way social media works is something we have a hard time understanding right now.”
core inflation problem
Visco called for patience in assessing the ECB’s rate-hike trajectory, especially as credit conditions tighten “significantly”. But he said policymakers would examine the data for signs that core inflation was falling and that the bank’s medium-term inflation target of 2 percent was approaching.
“In fact, if you look at the credit data, they show that growth has gone from over 10% in late summer to zero, and now it’s actually negative, so we’re tightening. We have to wait because there is a lag in monetary policy,” he said. He suggested that recent policy moves could take a year to 18 months to affect the euro zone economy.
Other ECB Governing Council members agreed that core inflation is the key indicator for the ECB to decide how far to raise rates and at what stage they can stop raising rates.
Lithuanian Central Bank Governor Gediminas Šimkus said the stickiness of core inflation was worrying and suggested it may not have peaked yet. However, he stressed the importance of assessing the lagged impact of existing policy tightening on the economy.
“A lot of what we’re doing, it’s not visible right now. … I believe we’re going to see core inflation come down even this year. But having said all that, I’d say a tight labor market, a buoyant The labor market, which adds an additional component to the overall picture … Headline inflation is falling, but services inflation, non-energy industrial goods inflation continue to rise,” Šimkus said.
“A lot of people ask what is the … terminal rate? But our decisions are made based on all kinds of data, macroeconomic forecasts, upcoming financial and economic data, it’s not just about inflation numbers … it’s about all these sets of data , forming a decision.”
Central Bank of Malta Governor Edward Scicluna also said the ECB “has a way to go” in responding to rising prices.
“There’s not much we can do about energy prices, but we’re very upset to see inflation start to come down, and wage earners are going to say ‘oh, we don’t believe it’s going to go down, so we’re going to ask for wage increases.'” The same goes for businesses. So yes, we are concerned that core inflation has not peaked,” Scicluna said.
He added that the magnitude of future rate hikes would be difficult to predict given economic developments, including concerns about the banking system, but said discussions of a pause or slowdown were taking place, suggesting policy rates were approaching a peak.
“It’s getting more difficult each time. It’s a good sign that the end of the tunnel is not far away,” he said.
“Not out of the woods yet”
Latvian Central Bank Governor Mārtiņš Kazāks emphasized this on Thursday, noting that the 20-member bloc is “clearly not out of the woods yet” and that the risk of a recession is “not small”.
“Inflation remains high. There is some risk of financial instability — Europe is doing well so far, and we have reason to be confident about that, but we have to watch the situation,” he told CNBC.
“However, we have also seen that the labor market has been very strong, much stronger than expected, which has led to the need for further increases in interest rates to contain inflation concerns, which may have some impact on vulnerable areas. Saw this happening.”
Asked how to balance the need to keep inflation in check with the risk of excessive tightening and further downward pressure on growth, Kazāks called on policymakers to remain focused on the inflation mandate, saying he saw “no reason to slow down anytime soon”.
“In my view, the risk of not doing enough to raise rates is significantly higher than the risk of doing too much,” he said.
Correction: This article has been updated with recent comments from Gediminas Šimkus, Governor of the Bank of Lithuania. Earlier versions contain outdated comments.