ECB likely to stick to big rate hike despite banking turmoil, source says

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FILE PHOTO: The logo of the European Central Bank (ECB) is pictured outside its headquarters in Frankfurt

By Francesco Canepa and Balazs Koranyi

FRANKFURT (Reuters) -European Central Bank policymakers are still leaning towards a half-percentage-point rate hike on Thursday, despite turmoil in the banking sector, as they expect inflation will remain too high in coming years, a source told Reuters.

Investors had begun to doubt the ECB’s commitment to another big rate hike this week after the collapse of Silicon Valley Bank (SVB) in the U.S. sent ripples through global financial markets.

But the source, who is close to the Governing Council, said the ECB was unlikely to ditch its plan to raise rates by 50 basis points on March 16 – announced at its last meeting and repeated several times by President Christine Lagarde and her colleagues – because that would damage its credibility.

Futures on German government bonds, the euro zone’s benchmark, fell after the Reuters report and the euro rose against the British pound.

The source added that formal proposals for the meeting had not yet been distributed but policymakers had seen the new quarterly projections.

The new inflation forecasts for the next two years will be lower than in December but still put price growth well above the central bank’s 2% target in 2024 and slightly above it in 2025.

An ECB spokesperson declined to comment.

Furthermore, forecasts for core inflation, which excludes food and energy prices, were set to be revised higher, emboldening calls for more rate hikes by policy hawks on the ECB’s Governing Council, the source added.

Still, dovish policymakers who have been preaching greater caution in raising borrowing costs and warning about the risk of financial instability felt vindicated by the recent market turbulence, the source said.

They were likely to push back against committing to further rate increases and say instead that any new move would depend on incoming data.

The ECB can push through decisions with a simple majority though President Lagarde has been known to seek the broadest possible consensus.

Money markets were pricing in an 85% chance of the ECB raising its deposit rate by 50 basis points to 3.0% on Thursday, with some banks including Deutsche Bank expecting a smaller or no increase.

Investors have sharply cut their bets on further rate rises since the SVB collapse, with the deposit rate now seen peaking at 3.65% in the autumn, compared with an outlook last week of more than 4%.

Euro zone supervisors see limited consequences for banks in the region from the collapse of SVB and two other lenders, while stressing the need to watch any further spillover closely.

SVB became the biggest U.S. bank to fail since the 2008 financial crisis after its outsized bets on U.S. government bonds and mortgage-backed securities went sour as a result of rising interest rates.

Its collapse forced U.S. authorities to spring into action at the weekend. After an initial rout on Monday, markets have become calmer amid hopes a wider financial crisis would be averted.

(Additional reporting by Frank Siebelt; Editing by Bradley Perrett and Andrew Heavens)

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