ECB backs big rate hike despite bank chaos

The European Central Bank carried through with a large interest rate increase Thursday, brushing aside predictions it might dial back as U.S. bank collapses and troubles at Credit Suisse feed fears about the impact of higher rates on the global banking system.

The ECB hiked rates by half a percentage point, underlining its determination to fight high inflation of 8.5%.

While some foresaw a smaller increase because of the banking turmoil, President Christine Lagarde repeatedly called the banking sector in the 20 countries using the euro currency “resilient,” with strong financial reserves and plenty of ready cash.

And if it became necessary, she said, the ECB is “fully equipped” to provide additional support to the banking system.

“We are monitoring current market tensions closely and stand ready to respond as necessary to preserve price stability and financial stability,” Lagarde said.

ECB Vice-President Luis de Guindos said the eurozone’s exposure to Credit Suisse, which is outside the European Union’s banking supervision structure, was “quite limited” and “not concentrated” in any one place.

Their message follows Silicon Valley Bank in the U.S. going under last week after suffering losses on government-backed bonds that fell in value due to rising interest rates. Then, globally connected Swiss bank Credit Suisse saw its shares plunge this week and had to turn to the Swiss central bank for emergency credit.

The troubles at Credit Suisse dragged down the shares of stalwart European lenders such as Deutsche Bank, BNP Paribas and Societe General on Wednesday. Bank shares recovered Thursday.

Analysts say the share selloff was fed by investor fear that banks took added risks to increase investment returns during years of very low interest rates and some may have failed to safeguard themselves against those holdings turning sour as rates rose.

As for more rate hikes in Europe, Lagarde said “inflation is projected to remain too high for too long” and that further increases will be based on what the numbers show. She did not commit either way, unlike her stance before Thursday’s meeting when she said a rate increase was “very likely.”

“Markets are assuming that this may be the ECB’s last rate hike, but the reality is that developments in the banking sector could shift either way in coming weeks,” said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management. “If the panic eases, the ECB is likely to resume tightening before long” with more increases.

Similar questions are being raised about what the U.S. Federal Reserve will do at its meeting next week.

Fed Chair Jerome Powell said only last week that the ultimate level for rates would be “higher than previously anticipated,” leading some analysts to predict the Fed would raise by a half-point after slowing the pace to a quarter-point in February. Since then, expectations shifted back toward a quarter-point.

European finance ministers have said their banking system has no direct exposure to the failures of Silicon Valley Bank and others in the U.S.

Analysts say the European banking system instituted wide-ranging safeguards after the global financial crisis that followed the collapse of U.S. investment bank Lehman Brothers in 2008 and led to 600 billion euros ($637 billion) in taxpayer-funded bailouts of European banks in 2008-2012.

Those sweeping banking reforms enacted by the European Union forced banks to hold thicker financial cushions against losses and put the biggest banks under the watchful eye of the ECB, taking them away from national supervisors who were considered to have turned a blind eye as problems built up at their home banks.

European banks also observe international rules that raised the amount of ready cash they had to keep on hand to cover deposits. Smaller U.S. banks were exempt from that rule; Silicon Valley was one of them.

All that hasn’t kept the U.S. banking blow-up and turmoil over Credit Suisse from the forefront for the ECB, whose leader said she saw “no tradeoff” between fighting inflation and preserving financial stability.

Credit Suisse, the No. 2 Swiss bank, saw its shares plunge as much as 30% on Wednesday after its biggest investor, Saudi National Bank, said it could not provide more financial support.

Credit Suisse, whose troubles predate the collapse of Silicon Valley Bank, then turned to the Swiss National Bank for up to $54 billion in credit to stabilize its finances, sending its stock soaring as much as 33% on Thursday.

SVB’s collapse raised concern that swift rate rises by the Fed and other central banks could lead to further problems in the banking system if banks were holding similar losses on their balance sheets.

The ECB has been raising rates at an unprecedented pace to contain inflation fueled by higher energy prices tied to Russia’s war in Ukraine. Its benchmarks affect the cost of credit across the economy, making more expensive to buy things or invest in new production. That cools demand for goods and eases upward pressure on prices.

The ECB’s rate for lending to banks was raised to 3.5%, and the rate it pays on deposits it takes from banks was lifted to 3%.