ECB Ploughs on with Interest Rate Hikes

By: Miguel A. Rodriguez

07:20, 05 May 2023

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Just after the US Federal Reserve (Fed) raised its rates for what is thought to be the last time this year, the European Central Bank (ECB) followed in its footsteps. Markets showed little reaction at first, but then concerns about the banking sector once again shacked up the financial scene.  

The market's expectations were confirmed by the ECB, which increased interest rates by 25 basis points and kept up its balance sheet reduction strategy. Contrary to the Fed, the ECB made it very clear that rate increases will continue in the future depending on economic data, particularly inflation, which is the monetary policy's goal. 

The market was barely affected by the ECB's decision because it was in accordance with expectations; there was just a tiny increase in the EUR/USD, which would initially gain from impending rate increases in the Eurozone. 

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However, as the market session went on, worries about the state of the US banking system overturned earlier optimism after the Fed hinted the previous day that rate hikes might be coming to an end. 

Shares of PacWest Bancorp dropped 49% and trading was suspended after the bank declared it was considering all strategic options, including a sale. Just a few days earlier, First Republic Bank's deposits and most of its assets were purchased by JPMorgan. 

The pressure spread to other regional bank equities as well; shares of Western Alliance sank as much as 38%, KeyCorp dropped 5.9%, and Zions Bancorporation dropped 9.6%. 

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Powell insists that the US banking system is sound, but the regional banking crisis is far from being resolved. Market participants bought bonds as safe haven assets out of fear of a larger crisis, which reduced the yields on treasury bonds and caused the Dollar to decline, especially versus the Yen. Gold kept rising and stock indices ended the day on a negative note, with the Dow Jones 30 being the most affected because of its greater exposure to the banking sector. This is a strong indication of risk aversion from investors who purchase the Yen as a safe haven.  

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Sources: Bloomberg, Reuters 

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