Will ECB temper rate hikes amid banking sector stress?

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European Central Bank May Adjust Rate Hike Pace Amid Banking Sector Stress

Financial institutions, including Goldman Sachs, HSBC, and Barclays, are revising their expectations for the European Central Bank's (ECB) May interest rate decision, anticipating a smaller quarter-point hike. This adjustment comes in response to recent turbulence in the global banking sector, exemplified by the collapses of Silicon Valley Bank and Signature Bank, and concerns surrounding First Republic Bank and Credit Suisse. While some banks foresee a shift to smaller increments, others like JP Morgan, Deutsche Bank, and SEB still anticipate a larger 50 basis point increase in May but acknowledge downside risks.
Anticipation of a Reduced Rate Hike in May

Goldman Sachs, previously expecting a 50 basis point increase, now forecasts a more modest 25 basis point hike for the ECB's May meeting. This revised outlook has also led Goldman Sachs to lower its terminal rate forecast to 3.5 per cent from 3.75 per cent. Similarly, HSBC and Barclays have adjusted their predictions, anticipating two subsequent 25 basis point hikes in May and June, while maintaining their terminal rate forecast at 3.5 per cent. Traders are currently pricing in a peak ECB rate of approximately 3.23 per cent by September or October.
Banking Sector Uncertainty Influences Forecasts

The global financial market volatility, triggered by significant banking failures and doubts about the stability of other institutions, has prompted some rate-setters within the ECB to advocate for a more cautious approach. This uncertainty has led major banks to reassess the pace at which the ECB might continue its monetary tightening cycle. Despite these market jitters, Goldman Sachs economists believe further rate increases are probable, citing a limited risk of severe contagion within the banking sector and the expectation of persistent strong core inflation.
Core Inflation Remains a Key Consideration

While the ECB has lowered its inflation projections for 2023 to 5.3 per cent, this figure remains substantially above the central bank's 2 per cent target. Core inflation, which excludes volatile components like energy and food prices, is anticipated by Goldman Sachs economists to remain robust in the coming months. This persistent underlying price pressure is a significant factor influencing central bank policy, suggesting that a complete halt to rate hikes may not be immediate, even with the current financial sector stresses.

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Will ECB temper rate hikes amid banking sector stress?

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