ECB Review: Business as Usual? Hardly…

Summary

• The ECB sounded reasonably hawkish at the policy meeting yesterday despite the banking sector stress.
• The Governing Council stuck with its earlier guidance and delivered another 50bps rate hike. It announced no new facilities to support banking sector liquidity.
• Forward guidance was limited to a data-dependent approach to future policy rate decisions.

No Trade-Off Between Price and Financial Stability

Despite the Credit Suisse turmoil, the European Central Bank (ECB) stuck to its guns yesterday and proceeded with a 50bp hike, bringing the deposit rate to 3%.

Christine Lagarde stressed several times that there was no trade-off between price and financial stability. Her rationale was that financial data impacts the inflation outlook. She highlighted the inclusion in the statement of three key elements of the ECB reaction function:

1. Incoming economic and financial data.
2. The dynamics of underlying inflation.
3. The strength of monetary policy transmission.

As price and financial stability are addressed with separate instruments, the ECB view seems to be that the potential need to intervene with liquidity support does not impede further rate hikes. And Lagarde’s comments that little progress had been made on underlying inflation and that much ground needs to be covered left a hawkish tone overall.

Not Business as Usual

Despite following through on the pre-committed hike, Lagarde said it was not business as usual. Amplified uncertainty in recent days (after the cutoff dates for the new forecasts) left downside risks to growth via tighter credit conditions and downside risks to inflation.  

Lagarde stressed that the ECB’s pre-existing tools are strong and can be reactivated at any time. She does not see a current need to explore alternatives, but this can be done quickly, within mandate, if needed.

Europe’s banking sector was described repeatedly as resilient. Capital ratios are higher than 10 years ago, liquidity positions are robust, and the composition of liquidity is high quality assets. Higher NIMs from rising rates have also benefitted banks. European bank shares are up slightly post ECB, but still down sharply on Tuesday. Overall, reversal of the YTD rally in bank shares was not enough to prompt ECB action on liquidity support.

Inflation Still Too High for Too Long

Updated forecasts received less attention than usual given the focus on the banking sector. But the upwardly revised 4.6% core inflation for this year looks optimistic, according to earlier analysis by Henry. And the 2.5% core inflation projection for next year is still too high for the ECB to stop hiking.

A deceleration seems likely at the next meeting on 4 May. But the ECB today certainly did not sound like an end to the tightening cycle was likely in the near term.     

Caroline Grady is a global economist at Macro Hive, specialising in emerging markets. Formerly, she was a Senior EM Economist at Deutsche Bank and a Leader Writer at the Financial Times.

Photo Credit: depositphotos.com

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