The European Central Bank is facing a dilemma over whether to push ahead with its plans for a large interest rise on Thursday amid fears over the strength of the banking system after Wednesday’s heavy sell-off of the Swiss banking firm Credit Suisse.
After raising interest rates since last summer at a record pace to tackle high inflation across the eurozone, the ECB had in effect committed to another 0.5 percentage point increase in borrowing costs this week.
However, financial markets have drastically cut back expectations for the central bank to push ahead with the plan. Before the rate decision on Thursday afternoon, trading in markets reflected an almost 50-50 chance that the ECB would go ahead with a 0.5 percentage point rise. Previously it was considered a certainty.
Analysts said the central bank could opt for a smaller 0.25 percentage point rise as concerns over the health of the banking system rippled through markets. It comes after the collapse of Silicon Valley Bank in the US rattled global banking shares earlier this week, stoking fears of a rerun of the 2008 financial crisis, and leading global investors to tear up their expectations for central bank rate increases.
Victoria Scholar, the head of investment at Interactive Investor, said: “Last week, a 50-basis point hike was almost an inevitability. However, the collapse of SVB and Credit Suisse’s turmoil have seen markets wind back their ECB expectations.
“Financial markets are now pricing in an increased chance of a 25-basis point hike, but whether the SNB’s support for Credit Suisse could embolden the ECB to continue with its hawkish path is yet to be seen.”
The ECB’s rate decision came as European markets recovered from a dramatic sell-off on Wednesday, when fears over the health of Credit Suisse, one of Europe’s biggest banks, wiped more than £75bn off the FTSE 100.
Shares in the Swiss bank plunged by as much as 30% after its largest shareholder, Saudi National Bank, ruled out further investment in the embattled lender. However, the shares rallied on Thursday after the Swiss National Bank, the country’s central bank, said late on Wednesday it was willing to provide Credit Suisse with a 50bn Swiss franc (£44bn) loan.
Paul Donovan, the chief economist at UBS Global Wealth Management, said the promise of support meant a further interest rate increase from the ECB was unlikely to have a material impact on the bank’s liquidity position. “The ECB can do little to change reputational risk. However, indifference to the situation might increase interest rate risks for the European financial sector at large,” he said.
“The ECB has seemed to run policy on autopilot in recent months. The markets are therefore expecting a rate increase today, but are uncertain as to scale. ECB President [Christine] Lagarde speaks after the decision. In the current climate, it is to be hoped that ‘misspeak’ is avoided.”
