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 Thursday, underlining its determination to fight high inflation of 8.5%. In a statement, the bank called the banking sector in the 20 countries using the euro currency "resilient," with strong finances.
"We are monitoring current market tensions closely and stand ready to respond as necessary to preserve price stability and financial stability," ECB President Christine Lagarde said at a news conference. Later adding, "I think that the banking sector is currently in a much, much stronger position than where it was back in 2008" during the global financial crisis.
The 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 rise.
Lagarde said "inflation is projected to remain too high for too long" and that further hikes will be based on what the numbers show.
Similar questions are being raised about what the U.S. Federal Reserve will do at its rate meeting next week.
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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 that 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 in taxpayer-funded bailouts of European banks in 2008-2012.
The sweeping post-Lehman 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.
But all that hasn't kept the U.S. banking blow-up from looming large for the ECB, whose leader said Thursday that "there is no tradeoff between price stability and financial stability."
Credit Suisse, the No. 2 Swiss bank, saw its shares plunge as much as 30% Wednesday after its biggest investor, Saudi National Bank, said it could not provide more financial support.
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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 30% on Thursday. That brought wider bank stocks back up.
Nicolas Veron, a banking expert at the Bruegel think tank in Brussels, said European banking supervision is much stronger than in 2007 when banks were "dramatically undercapitalized and poorly supervised." He also said that the ECB has been carefully studying the impact of higher rates on its banks.
"Having said that, if we had had our conversation a week ago, I would have expressed confidence in U.S. banking supervision as well," he said, calling the U.S. bank collapses evidence of "a pretty inexplicable supervisory failure" by the U.S. Federal Reserve.
"And so because the Fed has such status, this creates a kind of doubt across the board on the quality of supervision and whether what we think we know about banks is actually right," Veron said.
Silicon Valley Bank failed after it suffered losses on government-backed bonds that fell in value as interest rates rose. The U.S. Federal Reserve and other central banks have been sharply raising rates to combat inflation. SVB's collapse raised concern that swift rate rises 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. The ECB's 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%.
