ECB Surprises With 50bps Rate Hike

Does This Put Pressure On The Fed To Follow Suit?

The European Central Bank may just have made the Fed’s rate hike decision next week that much more complicated, with its surprise 50bps rate hike.

Inflation is projected to remain too high for too long. Therefore, the Governing Council today decided to increase the three key ECB interest rates by 50 basis points, in line with its determination to ensure the timely return of inflation to the 2% medium-term target. The elevated level of uncertainty reinforces the importance of a data-dependent approach to the Governing Council’s policy rate decisions, which will be determined by its assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission.

This was double what many analysts were expecting earlier yesterday.

The European Central Bank is more likely to raise interest rates by a modest 25 basis points when it meets on Thursday rather than by 50 bps or make no rate hike, Barclays said on Wednesday.

"At the current juncture, we think that the (ECB) Governing Council is more likely to announce an increase of all policy rates by 25bp, which we see as the highest probability outcome, rather than 50bp or no hike, to which we would ascribe lower but equal probabilities," Barclays said in the note.

The expectation of a 50bps hike largely evaporated after Credit Suisse shares plummeted in what has been a perfect storm of internal issues and global banking issues, including reverberations from the failures of Silvergate Capital, Silicon Valley Bank, and Signature Bank of New York last week.

Credit Suisse stock (NYSE:CS) is trading 25.5% lower due a combination of several pressures, some impacting the entire banking sector and some are more specific to Credit Suisse. In November 2022, I issued a sell rating on Credit Suisse stock and I can already mention that I'm maintaining that rating as I have not seen any signs that the bank can deal with the banking environment which currently is more challenging than a couple of months ago.

So, Credit Suisse and its share price deals with several challenges:

1. The current turmoil in the banking sector after the collapse of the Silicon Valley Bank.

2. Control lapses

3. Nervousness from investors

So bad is the situation at CS that the bank appealed to the Swiss central bank for support.

Credit Suisse has appealed to the Swiss National Bank for a public show of support after its shares cratered as much as 30 per cent, sparking a broader sell-off in European and US bank stocks.

The request for a reassuring statement about Credit Suisse’s financial health came after its shares sank as low as SFr1.56, having earlier been halted amid a heavy sell-off, according to three people with knowledge of the talks.

Taking a page from the FDIC’s playbook over SVB, the Swiss Central Bank and their financial regulator FinMa issued a joint statement pledging support for the beleagured Swiss banking giant, including liquidity support if need be.

Swiss regulators said Credit Suisse (CSGN.S) can access liquidity from the central bank if needed, racing to assuage fears around the lender after it led a rout in European bank shares on Wednesday.

In a joint statement, the Swiss financial regulator FINMA and the nation's central bank said that Credit Suisse "meets the capital and liquidity requirements imposed on systemically important banks."

This show of support apparently cleared the way for the ECB to proceed with the 50bps rate hike, its sixth in a row.

The central bank has now hiked interest rates at six consecutive meetings, lifting the cost of borrowing from near-zero to 3.5% as it battles to tame eurozone inflation, which still ran at a red-hot 8.5% in February.

The decision shows that the ECB is sticking to the plan it signaled at its February meeting, when policymakers said that they expected to bring in a 50 basis point hike. 

The move appears to have sparked a reversal in yields on the 10-Year German Bund (comparable to the 10-Year Treasury here in the US), which had been in decline recently after rising significantly over the past year.

It should be noted that foreign securities face the same yield pressures US Treasuries do—large positions in older, lower-yield securities are now worth that much less because of rising interest rates. As the ongoing issues at Credit Suisse illustrate, the rising rate environment is as challenging to European banks as American banks, if not more so.

Whether the 50bps hike will help tamp down inflation in the Eurozone is problematic, although the ECB is proving just as dedicated to the Volcker playbook as the Federal Reserve.

This move also adds pressure on the Federal Reserve to raise the federal funds rate again when the FOMC meets next week. The dollar sank in late day trading aginst the euro, aborting what looked like a recovery from an intraday low.

The dollar shows similar declines against the British pound as well.

The dollar decline was broad-based, as the dollar index, which measures the dollar against a basked of currencies, followed suit.

As I pointed out last summer, the Fed’s rate hikes also help defend the dollar’s relative strength against other fiat currencies.

This Is Why The Fed Can't Stop Hiking Rates

Bas van Geffen of Rabobank alludes to why the Fed wants to be in last place in the currency and economic race to the bottom: the strongest currency will be the one that crashes last.

While the Fed’s experience –how did we ever get from ‘transitory’ to ‘entrenched’?– serves as a warning for its peers, the bright spot of a more aggressive FOMC is that the ECB might just manage to get away with less tightening, possibly allowing European policymakers to take a little more care of the economy. If the Fed squeezes the life out of the US economy, that will undoubtedly have a global impact. It may therefore cool global aggregate demand just enough to take the biggest sting out of inflation. Yet, as the decline in the euro over the last week highlights, the ECB will obviously understand that a free ride does not exist.

Despite all the magic money printing of the past decade, and the loose money policies going back to Alan Greenspan’s tenure as Fed Chairman, by keeping a tighter hand on the monetary reins now, in the form of higher interest rates, the dollar may yet prove to be the strongest and most resilient of the world’s fiat currencies.

With the ECB for the moment sounding more hawkish than the Fed on interest rates and combatting inflation, this latest rate hike, and the relative boost it gives the euro against the dollar, adds pressure on the Fed to keep hiking rates if only to protect the dollar. If the strongest currency is truly the one that comes in last in the global economic race to the bottom, the Fed’s decision on rates next week just became that much more complicated.

The risk for the ECB is that Credit Suisse alone is a larger bank by total assets (€729.04 Billion) than Silvergate ($11.3 Billion), SVB ($209 Billion), and SBNY ($110.36 Billion) combined. Pushing Europe’s 17th largest bank that much closer to the brink could prove dangerous for Europe’s banking sector even with the support of the Swiss Central Bank.

Either the ECB does not recognize the global banking turmoil into which it has injected a relatively sharp rate hike, or it is betting that Europe’s banks can withstand the added stress and benefit from euro appreciation against the dollar.

By accident or design, the ECB has placed the Federal Reserve in the position of having to weigh making essentially the same bet next week on US banks.