The European Central Bank Raises Rates Half a Point Amid Uncertainty

The E.C.B. was the first major central bank to set monetary policy since banking worries gripped financial markets.

E.C.B.’s deposit facility rate since 1999

Source: European Central Bank

By The New York Times

Reporting from Frankfurt

The European Central Bank pushed ahead with a half-point increase in interest rates on Thursday, sticking to its previously stated inflation-fighting plan, but said the recent turmoil in financial markets had made the path ahead less certain.

Over the past few days, since the collapse of three midsize banks in the United States, investors have been gripped by worries about other banks, including the big Swiss lender Credit Suisse, and about the sector’s ability to withstand higher interest rates. The European Central Bank was the first major central bank to set monetary policy since the volatility began late last week.

Policymakers were “monitoring current market tensions closely,” Christine Lagarde, the president of the bank, said in a news conference on Thursday. The bank “stands ready to respond as necessary to preserve price stability and financial stability in the euro area,” she added.

Despite the added uncertainty, policymakers did not divert from the half-percentage-point rate increase that they first said in early February was coming. The bank said it would raise its deposit rate to 3 percent on Thursday, the highest since October 2008.

“Inflation is projected to remain too high for too long,” Ms. Lagarde said, adding that the move was needed to ensure the “timely” return of inflation to the bank’s 2 percent target. The bank’s staff has forecast that inflation will average 5.3 percent this year and still be slightly above the 2 percent target in 2025.

What follows in coming months is less clear. If the bank’s economic forecasts play out after the current market uncertainty subsides, Ms. Lagarde said, policymakers still have “a lot more ground to cover” on tightening monetary policy. But that’s a big if.

And that was a sharp change from the past few months, when the central bank had been lighting the way ahead for investors, committing to its next interest rate move in advance.

The data used to make the projections were final at the beginning of March, before the recent market turmoil, so policymakers were faced with even higher levels of uncertainty in their decision-making, Ms. Lagarde said.

There was “a degree of uncertainty that pre-existed, but that has certainly been amplified by the most recent financial tensions that we have observed in the last few days,” Ms. Lagarde said. “It’s obviously difficult for a group of 26 members of the Governing Council to come to a decision in the face of” incoming the economic and financial data, she added.

“We were certainly confident that this 50-basis-points rate increase was a robust decision considering the ground that needs to be covered,” she said, but later noted a few policymakers wanted more time to see how the situation unfolded.

ImageSkyscrapers rise in the distance and cars flow down a busy city street at night.
In Frankfurt, where European Central Bank officials met on Thursday. The bank said it “stands ready to respond as necessary to preserve price stability and financial stability in the euro area.”Credit...Michael Probst/Associated Press

As financial markets convulsed this week, traders reduced their bets on how high major central banks will raise interest rates this year amid the fallout of the collapse of the California-based Silicon Valley Bank and worries about Credit Suisse. Analysts have started to speculate that the U.S. Federal Reserve won’t be able to proceed as expected with higher interest rates as markets remain jittery about the health of many banks, particularly U.S. regional ones, and their ability to withstand higher rates.

The Fed and the Bank of England are both scheduled to meet next week to set interest rates.

The eurozone has little direct exposure to Silicon Valley Bank, but banking worries got much closer to home on Wednesday when Credit Suisse’s share price plunged to a record low after the Swiss bank said it found “material weakness” in its financial reporting controls, and its largest shareholder balked at injecting more funds for regulatory reasons.

Early on Thursday, Credit Suisse said it would borrow up to 50 billion Swiss francs, or about $54 billion, from Switzerland’s central bank and buy back some of its debt. Hours later, shares in Credit Suisse jumped when trading began and ended the day nearly 20 percent higher.

The European Central Bank stressed on Thursday that it had tools to protect financial stability in the region but said the banking system was “resilient, with strong capital and liquidity positions.”

It also highlighted a new tool, the transmission protection instrument, which was created in the summer and could be used to counter “unwarranted, disorderly market dynamics” that threatened the central bank’s ability to carry out its monetary policy decisions.

The central bank is “combating the two problems of price stability and financial stability with two separate instruments in order to avoid a conflict of objectives,” Jörg Krämer, the chief economist at Commerzbank, wrote in a note. He added there were good reasons for this because “the deep-seated inflation problem has not changed so far.”

He expects the bank to raise rates a quarter-point at each of its next two meetings, taking the deposit rate to 3.5 percent, lower than a previous prediction of 4 percent. The market turmoil could “dampen bank lending — and thus growth and ultimately inflation,” Mr. Krämer added.

Ms. Lagarde emphasized that future rate decisions would be “data dependent,” which included financial data. The bank would be particularly alert to lending to households and companies, and if restrictions appear and the extent of tightening of financial conditions on the economy.

“It’s not possible to determine at this time what the path will be going forward,” European Central Bank President Christine Lagarde told reporters after the bank meeting in Frankfurt Thursday.Credit...Heiko Becker/Reuters

Last month, policymakers at the E.C.B. said they expected to raise rates by half a point at this week’s meeting because they were committed to stamping out persistent inflationary pressures even as the inflation rate appeared to have peaked. Consumer prices in the 20 countries that use the euro as their currency rose at an annual rate of 8.5 percent in February, down slightly from January, and down from a peak of 10.6 percent in October.

Beyond the headline rate of inflation for the eurozone as a whole, the details were more concerning to some policymakers. Some major economies, including France and Spain, were reporting higher inflation. Core inflation, which strips out volatile energy and food prices and is used to measure how embedded inflation is in an economy, also rose last month.

Lower wholesale energy prices in Europe will help push inflation toward the central bank’s 2 percent target. But policymakers are focused on so-called underlying inflation, which will show whether inflationary pressures are still building and making it hard to meet the inflation target on a sustainable basis. Measures such as wage inflation and services inflation are being watched closely, and current underlying inflation trends don’t confirm that inflation is heading toward the target.

On inflation, “we are seeing some slight improvement in certain areas but frankly not a lot,” Ms. Lagarde said.

While markets remain jittery and the extent of the impact on the banking sector is still unknown, there is a risk that central banks could appear sidetracked from goals in bringing down inflation, having spent months warning that high prices could be more persistent than expected.

But Ms. Lagarde tried to push back against suggestions that the European Central Bank would declare victory on the fight against inflation prematurely. “We are not waning on our commitment to fight inflation,” she said. “ That should not be doubted. The determination is intact.”