FRANKFURT – The European Central Bank decided to raise interest rates by 0.5 percentage points to 3 percent Thursday, sticking to its previous guidance even as fears about a new financial crisis have roiled markets in recent days.
Policymakers clearly opted to prioritize a continued fight against raging inflation over financial stability concerns noting that “inflation is projected to remain too high for too long.”
After the collapse of two U.S. banks and turmoil at Swiss banking giant Credit Suisse, worries about a potential banking crisis raised doubts over the ECB’s previously signaled rate path — sending financial markets’ bets on a likely move today and peak interest rates on a rollercoaster ride since Monday.
Today’s decision will expose ECB President Christine Lagarde to criticism that she is repeating mistakes made by former President Jean-Claude Trichet, who raised rates into the 2011 sovereign debt crisis arguing that anchoring inflation expectations is the best way to boost confidence in the single currency area.
The move has gone down in history as a massive policy error that scarred the ECB’s credibility for years.
The ECB acknowledged the current uncertainty and dropped a reference to having to raise interest rates “significantly” further, instead underlining its readiness to react to incoming data.
“The elevated level of uncertainty reinforces the importance of a data-dependent approach to the Governing Council’s policy rate decisions, which will be determined by its assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission,” it said.
The ECB also assured that the Governing Council “stands ready to respond as necessary to preserve price stability and financial stability in the euro area,” while assuring that the region’s banking sector is resilient. “In any case, the ECB’s policy toolkit is fully equipped to provide liquidity support to the euro area financial system if needed and to preserve the smooth transmission of monetary policy,” it said.
The ECB’s policy decision came with new forecasts for growth and inflation which had been finalised in early March before the start of the recent financial market tensions.
Inflation forecasts have been revised down, mainly on lower energy prices, with ECB staff now seeing inflation averaging 5.3 percent in 2023, 2.9 percent in 2024 and 2.1 percent in 2025. At the same time, however, they revised up their estimates for underlying inflation pressure, suggesting prices could prove stickier than previously thought.
Eurozone economic growth has been revised up to an average of 1.0 percent this year as a result of both the decline in energy prices and the economy’s greater resilience to the challenging international environment. For 2024 and 2025, forecasts have been trimmed to 1.6 percent owing to the tightening of monetary policy.
With inflation still seen overshooting the bank’s target well into next year, the ECB may continue to face a dilemma between securing financial stability and ensuring price stability.
Ahead of Thursday’s rate move, former dovish ECB policymakers Lorenzo Bini Smaghi and Vítor Constâncio had warned that the central bank must avoid a repeat of the 2011 policy disaster. “The ECB should avoid repeating the 2011 mistake, when it continued hiking rates without taking into account the growing contagion from the Greek debt restructuring,” Bini Smaghi told Germany’s Börsen-Zeitung. In a similar vein, Constâncio tweeted that central banks “should not ignore the signs from the markets,” and called on the ECB to drop plans for a 0.5 percentage point hike.
To be fair, however, the trade-off now between financial stability and price stability seems far less obvious than it was in 2011 — at least in hindsight: While so far not a single eurozone bank has had to receive support, back in the day the eurozone started to bail out its third member country.
Today, inflation still runs at more than three times the ECB’s 2 percent target after hitting double digits, while in 2011 inflation barely topped 3 percent.
Some analysts had argued that changing tack would have been even riskier: “Backing off from an already announced rate hike with such short notice risks raising further questions and concerns about the stability of the euro area financial system, especially on the risks of larger deposit withdrawals that could trigger fire sales at individual banks,” Societe Generale economist Anatoli Annenkov said before Thursday’s move.
All eyes will now turn to Lagarde’s press conference and possible clues about the ECB’s policy path ahead.
This article has been updated.
