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ECB Increases Interest Rates Despite Concerns Over Financial Stability

The European Central Bank (ECB) increased interest rates by a half percentage point on Thursday, sticking to the plans set out last month despite financial stability concerns brought about by the collapse of Silicon Valley Bank in the U.S.[0]

The ECB's statement stated that inflation is projected to remain too high for too long and that the Governing Council had decided to increase the three key ECB interest rates by 50 basis points, in line with its determination to ensure the timely return of inflation to the 2% medium-term target.[1] The ECB staff macroeconomic projections were finalised in early March before the recent emergence of financial market tensions.[2]

Inflation data support ongoing hawkish rhetoric at the ECB but financial stability risk has markets substantially re-price the path for policy rates lower. In February, the inflation rate in the euro area was 8.5%, which is far more than the European Central Bank's (ECB) target of On Thursday, the ECB released its newest projections that show inflation hovering around 2%, the bank's mid-term goal, by 2025.

The European Central Bank (ECB) will increase the main refinancing operations rate to 3.50%, the deposit facility rate to 3.0%, and the marginal lending rate to 3.75%.[3] The ECB's statement also acknowledged the euro area banking sector's resilience with strong capital and liquidity positions, and that its 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.[1]

The ECB is now in a delicate balancing act between inflation and financial stability risks. The risk of miscommunication is high at this meeting, and the ECB is facing a difficult task in delivering price stability while safeguarding financial stability, as rising rates expose vulnerabilities that have accumulated during years of record-low borrowing costs.[4]

Given the ECB’s strong guidance around a 50bp hike at the March meeting, it is expected that the degree of data dependency, forward guidance, along with views on inflation and growth should drive the market reaction within the dovish/hawkish spectrum.[5] The ECB is monitoring current market tensions closely and stands ready to respond as necessary to preserve price stability and financial stability in the euro area.[3]

0. “ECB Sticks to Rate Hike Plan Despite Banking Turmoil” Barron's, 16 Mar. 2023, https://www.barrons.com/articles/ecb-meeting-interest-rate-decision-4958e65d

1. “Citing too-high inflation, ECB hikes rates by a half percent” UPI News, 16 Mar. 2023, https://www.upi.com/Top_News/World-News/2023/03/16/eu-ecb-rate-lagarde-inflation-50bp/7101678978597

2. “ECB Delivers 50bps Hike Despite Banking Sector Woes, EURUSD Indecisive” DailyFX, 16 Mar. 2023, https://www.dailyfx.com/news/ecb-delivers-50bps-hike-despite-banking-sector-woes-eurusd-indecisive-20230316.html

3. “ECB raises rates by 50 basis points, as inflation trumps financial stability fear By Investing.com” Investing.com, 16 Mar. 2023, https://www.investing.com/news/economy/ecb-raises-rates-by-50-basis-points-as-inflation-trumps-financial-stability-fear-3032496

4. “Big ECB Hike Called Into Doubt by Credit Suisse: Decision Guide” Yahoo News, 16 Mar. 2023, https://news.yahoo.com/big-ecb-hike-called-doubt-052358331.html

5. “ECB Cheat Sheet: Predictably unpredictable” ING Think, 13 Mar. 2023, https://think.ing.com/articles/ecb-cheat-sheet-predictably-unpredictable