The European Central Bank has raised interest rates across the eurozone by 0.5 percentage points, despite fears that higher borrowing costs could set off a domino effect across a banking sector already reeling from a collapse in confidence in Switzerland’s second largest lender, Credit Suisse.
Officials at the ECB, the central bank covering the 19-member euro bloc, said inflation was likely to remain high “for too long”, forcing it to continue with its planned run of rate increases.
The 0.5 percentage point rise pushes the bank’s main rate up to 3.5%, while the rate paid on eurozone bank deposits left at the ECB increases to 3%.
At its last meeting in February, the ECB clearly signalled its intention to hike the rate this month, but financial markets had been betting on a last-minute U-turn in light of this week’s turmoil.
The decision to push ahead with inflation control measures came hours after the Swiss Central Bank stepped in with a 50bn Swiss francs (£44bn) loan facility for Credit Suisse. The intervention was designed to calm fears over the finances of the lender, one of 30 banks globally deemed too big to fail.
Without referencing the overnight rescue loan, the ECB said on Thursday that its governing council was “monitoring current market tensions closely” and stood “ready to respond as necessary to preserve price stability and financial stability in the euro area”.
In a statement designed to quell fears over contagion in the banking sector, the ECB said: “The euro area banking sector is resilient, with strong capital and liquidity positions. In any case, the ECB’s policy toolkit is fully equipped to provide liquidity support to the euro area financial system if needed and to preserve the smooth transmission of monetary policy.”
Christine Lagarde, the president of the ECB, said the central bank would treat the heightened tensions in financial markets separately from its strategy for bringing down inflation.
While the ECB recognised a link between the two, Lagarde said: “We don’t see a trade-off between price stability and financial stability and handle them separately. We are not waning on our commitment to fight inflation and we are determined to return inflation back to 2% target in the medium term.”
She added that “there were three or four dissenters” on the ECB’s governing board who had argued for a pause in rate rises, but otherwise it “moved quickly” to a decision in favour of a 0.5% rise.
Fears over Credit Suisse, the world’s 17th largest bank, wiped more than £75bn off the FTSE 100 on Wednesday, with banking stocks across Europe taking a pummelling.
The sell-off was triggered after the chair of Saudi National Bank, the largest Credit Suisse shareholder, ruled out any further investment. The comments spooked markets as they came days after the collapse of the US lender Silicon Valley Bank.
While the share price rebounded on Thursday, speculation is mounting that Credit Suisse will be forced to spin off parts of the business or consider a takeover. Analysts at JP Morgan said withering confidence in its operations left the bank with three credible options: fully closing its investment bank, convincing the central bank to guarantee all of its customers’ deposits and potentially part-nationalise the lender, or welcoming a sale to larger Swiss rival UBS.
Analysts at US investment bank Keefe, Bruyette & Woods agreed that a break-up of the bank was the “most likely solution” to restore trust. “Given recent events, we believe further asset sales are likely, in our view.” Credit Suisse declined to comment.
Thursday’s ECB decision ups the stakes for eurozone banks. Several economists, including Nouriel Roubini, the New York University professor credited with predicting the 2008 banking crash, had warned that a 0.5% interest rise by the ECB could be the trigger for a broad-based solvency problem across the financial industry.
The credit ratings agency Moody’s said the Swiss government’s AAA rating was safe, despite the large loan to Credit Suisse, because Berne’s economic fundaments were strong. The Swiss government had ample firepower to protect consumers and its institutions were “highly effective” and able to deal with financial shocks, Moody’s added.
Josie Anderson, a senior economist at the CEBR consultancy, said the sixth consecutive rate rise by the ECB was aimed at tackling inflation, which remained high across the eurozone at 8.5% in February
“However, this was a bold move in light of the banking sector crisis which has emerged over the past week. Indeed, concerns about financial stability could lead to more moderate interest rate rises in the future.”