ECB hikes rates amid new US banking turmoil
The European Central Bank hiked its interest rate benchmark by half a percentage point on Thursday, despite fears that market turmoil caused by embattled lender Credit Suisse could spark a wider financial meltdown.
The ECB said it “stands ready to respond” and is “monitoring current market tensions closely” after Credit Suisse was thrown a lifeline overnight by Switzerland’s central bank, in the form of an unprecedented £45bn loan.
While the support for Credit Suisse helped sooth the markets there are new worries over the fate of the San Francisco-based First Republic Bank, whose shares collapsed on Thursday.
It’s the latest sign that all is not well in the banking sector after a tense few days. On Wednesday, Credit Suisse revealed it had found “material weakness” in its financial reporting, prompting its biggest shareholder, Saudi National Bank, to say it would not buy more shares in the bank, sparking panic among other investors. Its share price plunged by 24%.
Fears that Credit Suisse’s troubles could spread throughout the sector sent stock markets tumbling. Given the shock collapse of Silicon Valley Bank last week, the 16th biggest lender in the US, investors are understandably twitchy.
The Swiss central bank’s intervention calmed fraying nerves. European markets rallied on Thursday, the FTSE closed 0.9% higher, and Credit Suisse’s share price recovered 19% after Wednesday’s nosedive.
While the immediate collapse of Credit Suisse seems to have been averted, First Republic’s plight adds to the sense that the global financial system is vulnerable.
The root of the problem is rising interest rates. Because the 2008 financial crisis was the result of a housing bust and reckless lending, regulators clearing up the mess tried to ensure that banks held assets that would always have a reliable pool of buyers. Government bonds ticked this box, and the regulators encouraged banks to buy them. Lending to a state is considered a pretty safe bet, after all.
But the underlying assumption was that interest rates would remain at rock-bottom. When rates rise, the value of longer-term bonds falls. Which is why so many banks, funds and other firms which invested heavily in government bonds are now struggling because they are sitting on unrealised losses on billions’ worth of bonds.
This banking sector turbulence adds weight to the argument made by monetary doves that interest rates should peak sooner rather than later – or, indeed, yesterday.
Most would acknowledge that the ECB was in a difficult position. Eurozone inflation is still running red-hot at 8.5%. But as Josie Anderson writes on Reaction, while the Bank has a mandate to bring inflation down to 2.0%, it must also maintain financial stability in the Eurozone. Further interest rate rises risk heaping more pressure on an already fragile system.
Across the Atlantic, analysts now think it’s unlikely that the US Federal Reserve will make a 50-basis point rise when it meets next week, as was anticipated before the SVB crisis. Markets have priced in the Fed beginning to cut interest rates in the summer.
And here in the UK, the Bank of England’s monetary policy committee will also have to weigh taming inflation against the risk of precipitating a downturn when it meets next week.
Given market jitters, and with the UK economy still teetering on the edge of recession, the Chancellor’s boast yesterday that a rosier economic outlook is “proving the doubters wrong” seems a little premature.
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