Following a meeting of its Governing Council today, the European Central Bank (ECB) announced that its core interest rates would increase by 50 basis points. This takes the central bank’s main refinancing operations rate, marginal lending facility rate, and deposit rate to 3.50%, 3.75%, and 3.00%, respectively. It also marks the sixth consecutive ECB rate hike since monetary tightening began in July last year. The Governing Council did acknowledge the current financial sector strain, though it stated that the Eurozone “banking sector is resilient, with strong capital and liquidity positions”.

This tightening was broadly anticipated, as policymakers had effectively committed to the rise in previous statements. Furthermore, the argument to raise rates was solidified by the fact that core inflation (which excludes food and energy) in the Eurozone increased in the latest data for February, up to 5.6% from 5.3% in January. Though slower energy price growth meant that headline inflation fell, all of the other key consumption categories saw higher inflation rates in February than in January. This acceleration was most pronounced in food, alcohol & tobacco, where prices increased by 15.0% annually in February, up from 14.1% in January, and amounting to a record high. The ECB will need to see reduced price pressure across the wider economy and not just the energy sector before it can declare a sustained slowdown in inflation.

However, the collapse of Silicon Valley Bank (SVB) in the United States, and volatility in Credit Suisse shares, have raised concerns about banking sector stability for policymakers across the world. While the ECB has a mandate to bring down the rate of inflation to 2.0%, it also has to maintain financial stability of the currency zone, and further interest rate rises risk placing pressure on a fragile system. Indeed, it seems unlikely that the Federal Reserve in the US will make a 50 basis point rise when it meets next week, as was anticipated before the SVB crisis, in light of current events.

While falling energy prices have improved the inflation outlook for the Eurozone economy this year, if the ECB is forced to take its foot off the economic break and slow or pause interest rate rises in response to the banking crisis, there is a risk that inflation will start to accelerate again. The higher interest rates announced today combined with a possible worsening of the banking crisis paint a difficult picture for business activity, which will impact GDP growth. Overall, Cebr’s latest forecasts expect growth of just 0.5% in 2023, down sharply from 3.5% in 2022, with a subdued outlook for subsequent years.

Josie Anderson is Managing Economist at the CEBR.

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