European Central Bank sticks to its guns on interest rates despite market turmoil
The European Central Bank (ECB) has maintained its fight against inflation and imposed a large set of interest rate hikes despite market turmoil.
Bank balance sheets have suffered because of the effect of interest rate increases, which are thought to have contributed to recent crises at Silicon Valley Bank and Credit Suisse.
But the central bank – responsible for monetary policy in the 20 nations which use the euro as their currency – has stuck to its original plan to tackle inflation through rate rises.
Last week. it had been widely expected to impose the 0.5 percentage point hikes across its three main interest rates to maintain its battle against inflation.
Market speculation grew on Wednesday, though, that it would shy away from such rises given the market mayhem that had taken hold in the wake of Silicon Valley Bank‘s collapse – hitting the stocks of all major European banks hard.
It culminated in a rout for shares in major Swiss lender Credit Suisse, which later took a financial lifeline to shore up confidence.
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The ECB said it took its decision because “inflation is projected to remain too high for too long”, describing its banking system as “resilient”.
‘Elevated level of uncertainty’
Banking shares on the continent took another hit in response to the rate rises.
The ECB itself had reportedly warned EU politicians that some euro area banks could be vulnerable.
But the dip in share prices came despite the central bank’s assurances that it was aware of the sensitivities surrounding its rate hikes.
“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”, the statement from the ECB said.
“The Governing Council is monitoring current market tensions closely and stands ready to respond as necessary to preserve price stability and financial stability in the euro area.”
It highlighted the current “severe” market tensions as a potential risk to the eurozone economy as the pressure on banks could dampen the provision of credit.
At a news conference, ECB president Christine Lagarde added: “The [economic] projections that we have do not incorporate any of the most recent developments and certainly not the impact of the most recent financial tensions that we have observed on the markets.
“So there is a level of uncertainty that has been completely elevated because of that [and] that is the reason why
we reinforce the principle of data-dependency [in our future policy decisions].”
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‘We see this as a wise move’
UK bank stocks remained in positive territory in the wake of the rate hikes with only NatWest dragging on the FTSE 100.
Major US banking stocks were down by about 1% at the open in New York – building on the big losses of recent days.
The meltdown for banking and many other financial services stocks reflects deep concerns among investors for the health of their balance sheets due to rising interest rates.
The aggressive pace of rate hikes across Western economies has raised the cost of servicing their debts and placed a greater strain, to varying degrees, on their balance sheets.
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Silicon Valley Bank – what happened?
Regulators, including those in the UK, have insisted that there is no systemic risk and that banks are far better capitalised than they were before the financial crisis.
Matthew Ryan, head of market strategy at financial services firm Ebury, said: “The ECB stuck to its guns today in delivering a 50bp rate hike, despite the acute uncertainty in markets triggered by the collapse of Silicon Valley Bank and the slump in European banking shares.
“We see this as a wise move, as not only does sky-high core inflation and a resilient euro area economy warrant additional policy tightening, but the larger hike sends a clear signal of confidence in the strength of the European banking sector.
“In our view, a 25bp rate increase may have also raised question marks about the ECB’s credibility, given the thorough hawkishness of the bank’s recent forward guidance.”
After hitting the highest level this century on Tuesday, the cost of long term UK government borrowing has now hit a fresh 27-year high.
The interest rate demanded by investors on the state’s long-dated borrowing (30-year bonds) rose to just below 5.75%, surpassing the 5.72% peak reached on Tuesday, pushing it to a high not seen since May 1998.
It comes as the government auctioned off these long-term loans on Tuesday and was forced to pay a premium to do so.
Issuing bonds is a routine way states raise money.
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As well as meaning the state has to pay more to borrow money, high interest rates on debt can signify reduced investor confidence in the ability of the UK to pay back these loans.
As the trading session continued, the interest rates on long-term government bonds, known as gilt yields, fell back to just above 5.66%, not enough to erase two days of rises.
The benchmark for state borrowing costs, the interest rate on 10-year bonds, also saw rises. The yield rose above 4.8% for the first time since January, before slightly falling back
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Why did UK debt just get more expensive?
The spiked borrowing cost also continued to cause a weakening in the pound.
After an initial fall to a month-long low against the dollar, one pound again buys $1.34.
It means sterling goes less far in dollars than before the latest peak in interest rates on government bonds. On Monday, sterling could buy $1.35.
Sterling dropped to equal €1.14 before easing up to €1.15. Just a few months earlier, a pound could buy €1.19 before Donald Trump’s April country-specific tariff announcements.
So why has this happened?
Government borrowing costs have been rising across the world amid a sell-off in bonds – which prompts investors to look for a higher return to hold them.
High inflation and national debts have increased concern about whether states can pay back the money.
Japan’s long-term borrowing cost hit a record high, while the yield on the US’s benchmark 10-year bond hit the 5% mark for the first time since July.
UK bond yields tend to follow the US.
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Key to easing UK borrowing costs was the announcement of the date of the budget on Wednesday morning.
UK public finances had been a worry for markets as Chancellor Rachel Reeves struggles to stick to her fiscal rules to bring down the debt and balance the budget.
Disquiet around comparatively low growth in the UK economy also played a role.
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