Monday, March 27, 2023

Interest rates: What does the ECB’s change of tactics mean? – On Wednesday, the Fed’s decisions

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On Wednesday, the US Federal Reserve (Fed) will make decisions on rate hikes amid the new major banking crisis.

In particular, the turbulence on the markets in the past week, first due to the bankruptcy of the American bank Silicon Valley Bank (SVB) and then the problems of the Swiss Credit Suisse, prompted many analysts to lower their expectations of interest rate hikes from the European Union Central Bank (ECB ) and the US Federal Reserve (Fed).

The ECB basically failed to confirm these expectations last Thursday when it raised interest rates by half a percentage point, as announced since February, in order to bring inflation down to its target of 2%. However, she carefully avoided hinting at further rate hikes in the future, as in her previous announcements, and stressed the need to base decisions at each meeting on the then available data on the trajectory of the CPI and structural inflation. After Thursday’s hikes, the deposit rate is 3% and the refinancing rate is 3.5%.

What Christine Lagarde Said About Interest Rates

ECB President Christine Lagarde said the current outlook for the future interest rate path could not be given, citing additional uncertainty about the inflation outlook due to market turmoil.

The ECB’s new forecasts for euro-zone inflation, prepared ahead of last week’s events, show a faster deceleration than last December’s forecasts due to the sharp drop in energy prices. Specifically, annual average inflation is expected to be 5.3% this year, 2.9% in 2024 and 2.1% in 2025, which is also the medium-term reference horizon for central bank decisions. In December, inflation was expected to be 6.3% this year, 3.4% in 2024 and 2.3% in 2025.

The downward revision of the inflation forecasts probably points to a reduced need for monetary policy adjustments. Lagarde said that based on these forecasts, if they are to be reviewed in the face of the recent turmoil, “more ground” would need to be covered, implying that further rate hikes would be required, while previous interviews suggested “a lot of ground” had been covered had to become.

On Wednesday, the Fed’s decisions

So the question is whether the turmoil will actually lead to a significant change in inflation forecasts, which in turn would change interest rate policy. For example, if there were a significant fall in stock markets and a climate of additional uncertainty, this could lead to a fall in demand that would make it easier to reduce inflation. However, this is still too early to tell as the crisis is very fresh and no one can know if and to what extent it will escalate or if they “wipe out” following the interventions by the Fed and the Swiss central bank to provide liquidity ” becomes.

Next Wednesday, the Fed will also announce its interest rate decisions, which are also awaited with great interest. Before the SVB default, investors expected the Fed to raise interest rates by 50 basis points (half a percentage point) to fight inflation, but since then the hike is expected to be capped at 25 basis points. The Fed rate today is between 4.5% and 4.75%.


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