Markets expect rate hikes to end – decisions and reactions

Frankfurt Christine Lagarde and her colleagues on the ECB Governing Council lived up to the expectations they had set for themselves. Interest rates in the euro area will rise by 0.5 percentage points, as previously signaled. The central bank announced this on Thursday in Frankfurt after its most recent council meeting.

However, the central bank is no longer committed to further increases. In addition, Lagarde made it clear that the ECB is ready to help banks if necessary if they experience liquidity problems. An overview of the most important decisions and reactions.

The ECB has raised interest rates in the euro area by 50 basis points. The key interest rate is now 3.5 percent. The deposit interest that banks receive for their deposits at the central bank rises to 3.0 percent.

With the interest rate hike, the central bank is responding to the high inflation in the euro area. The ECB is particularly concerned about core inflation adjusted for energy and food. It rose to a record high of 5.6 percent in February. Central bankers pay close attention to core inflation because it is considered a reliable indicator of the medium-term inflation trend.

Lagarde said the council had not discussed any option other than a 50 basis point increase. The decision was also made very quickly.

However, there were also dissenting voices. “Three or four” Council members did not support the decision. According to Lagarde, the dissenters had wished to wait with the decision.

Unlike in December and February, the ECB is not signaling further rate hikes beyond the current meeting. However, Lagarde made it clear that they wanted to fight inflation with determination. An important indicator for further decisions is how quickly the higher interest rates affect the economy.

The current situation

In response to the turmoil in the financial sector, Lagarde stated that the ECB stands ready to help banks if needed. A number of instruments are available to strengthen the stability of the financial system and to provide the financial institutions with liquidity. From the ECB President’s point of view, however, the banking sector in the euro zone is “resilient and well capitalised”. The situation of the banks cannot be compared to that before the 2008 financial crisis.

The President of the ECB expressly denied a possible conflict of objectives between the fight against inflation and the stability of the financial system. With today’s interest rate hike, the ECB has clarified its position to counter high inflation despite adversities.

>> Read here: This is how ECB President Lagarde explains the new decisions

This is how the markets react

The markets reacted positively to the ECB’s decisions. In the late afternoon, the Dax was up almost two percent at over 15,000 points. The yield on ten-year Bunds fell below the 2.2 percent mark, but recovered somewhat over the course of the session.

In fact, rising interest rates tend to be bad for stock prices and cause bond yields to rise. The markets apparently interpreted the decisions as a signal for the end of the rate hike cycle.

The economist at Swiss wealth manager Pictet, Frederik Ducrozet, believes the reality is more complicated. Developments in the banking sector could go either way. “When the panic subsides, the ECB will likely tighten monetary policy again soon,” he expects.

Lagarde had said that the ECB would have to take further action if the forecasts for inflation and growth develop. The forecasts are particularly uncertain this time because they only take into account data up to mid-February. The current turbulence on the markets therefore had no impact.

That’s what economists say

Most economists approve of sticking to the interest rate hike that had been signaled in advance. The decision expresses “legitimate confidence in the solidity of the European banking system,” says Dekabank’s chief economist, Ulrich Kater.

Commerzbank chief economist Jörg Krämer also praises the decision. Despite the market turbulence, the ECB did not allow itself to be dissuaded from the course it announced in February. “This investment in their credibility is necessary because inflationary risks remain significant.”

Unlike some investors, who no longer expect further interest rate increases, Krämer assumes further steps. He believes that the ECB will raise the deposit rate to 3.5 percent in the coming months.

>> Read here: ECB Council member Robert Holzmann calls for further rate hikes by the central bank

The well-known capital market expert Mohamed El-Erian especially praised Lagarde’s communication. In a special market situation, she answered difficult questions clearly and decisively and communicated “masterfully”, wrote El-Erian on Twitter.

The predictions

Four times a year, the ECB also publishes its new forecasts on the short and medium-term development of inflation and growth. They show that headline and core inflation could continue to move in opposite directions in the coming months.

The ECB expects average inflation of 5.3 percent for the current year. This is well below the last estimate in December (6.3). The central bank is anticipating an inflation rate of 2.9 percent next year (December: 3.4), and 2.1 percent in 2025 (2.3).

The ECB is more pessimistic about the much-publicized core inflation. It has increased its forecast for 2023 by 0.4 percentage points compared to December to 4.6 percent. The expectation for 2024 is somewhat lower at 2.5 (2.8) and 2.2 (2.4) percent.

Due to the strong job market and the fall in energy prices, the monetary authorities are again significantly more optimistic about the economy. They expect economic output to grow by 1.0 percent in the current year. The forecast is twice as high as in December. The prospects for 2024 and 2025 have deteriorated slightly by 1.6 percent each. The ECB refers here to the braking effects of the tighter monetary policy.

More: Trade union confederation warns ECB against further interest rate hikes – “Collateral damage would be enormous”

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