The biggest bank failure since the 2008 financial crisis, the rout of Silicon Valley Bank (SVB) creates an additional challenge for the steering of ECB rates, even if the authorities and leaders on both sides of the Atlantic have made an assault of statements minimizing the risk of contagion.

Concern rose a notch on Wednesday with the unprecedented fall in the share price of Credit Suisse, the Swiss banking giant, which dragged European stocks in its wake.

This plunge began after statements by the president of the Saudi National Bank, Credit Suisse's largest shareholder, casting doubt on his support for this institution considered vulnerable.

These turmoil complicate the decision of the guardians of the euro who want to fight persistent inflation without further destabilizing the financial markets.

"Not painless"

Until recently, a 50 basis point hike at Thursday's monetary policy meeting was almost a no-brainer – as the ECB itself announced last month. But the scenario of a quarter-point increase is no longer excluded by the markets.

The situation "should not deter the ECB from raising interest rates by an additional 50 basis points, due to stubbornly high inflation," said Agnese Ortolani, an analyst at the Economist Intelligence Unit (EIU), like many experts.

European Central Bank President Christine Lagarde on February 15, 2023 at the European Parliament in Strasbourg © Frederick FLORIN / AFP/Archives

This decision would bring the rate remunerating bank liquidity not distributed in credit to 3.0%, the highest since October 2008.

Faced with soaring prices in the wake of the Russian offensive in Ukraine, the ECB began an unprecedented cycle of rate hikes in July, stopping nearly a decade of cheap money.

This forced monetary tightening, carried out by all major central banks to increase the cost of credit and slow down price overheating, has also contributed to weakening commercial banks.

This will animate the debate on Thursday among central bankers in the euro zone on the pace to follow in the coming months.

The financial turmoil proves that "the rise in rates is not as painless as it seems", giving credit to "doves" preaching caution, says Gilles Moec, chief economist at Axa.

The "hawks", who want to stay the course, will argue that there is no risk of contagion to the economy and therefore "no impact on the calibration of monetary policy", according to him.

Especially since the battle against inflation is far from over and is still putting pressure on the ECB.

Eurozone inflation fell in February for the fourth month in a row, to 8.5% year-on-year, but the price curve, excluding energy and food, climbed to a record 5.6%.

The new inflation and growth forecasts published by the institution on Thursday will help it reassess the situation.

Rate peak at 3.5%?

It will be up to ECB President Christine Lagarde to weigh every word of her communication on the future evolution of rates.

"The extreme uncertainty that currently reigns over the US banking sector and the reaction of the markets should encourage the institution to be more cautious," said Frederik Ducrozet, chief economist at Pictet Wealth Management.

The level of the deposit rate could peak between 3.5 and 4.% this summer, according to observers, with more likely now to land at the lower end of the range.

"The risk to financial stability" is forcing markets to "reassess the path of rates downwards," according to ING Bank.

The ECB can also fight inflation by reducing the stock of public and private debt and giant loans to banks accumulated on its balance sheet.

Described as a "monetary vacuum cleaner" by economist Ludovic Subran, an expert at Allianz, this tool is particularly sensitive at a time when European banks must not lack liquidity and when the risk of financial accidents looms.

© 2023 AFP