Policymakers Hopeful of Cooling Down Economy and Controlling Inflation, but Risk of Crisis Looms

Central bankers in the US and Europe have expressed optimism about the health of the banking system, despite signs of instability in the financial markets. Policymakers continue to see the banking crisis as a means of cooling down the economy and lowering inflation, but this may not be possible if the crisis worsens.

Western Alliance Shares Plummet Amid Sale Rumors as Fed Stays Optimistic on Banking System Health

Shares of PacWest and Western Alliance have plummeted by over 40%, with investors concerned that the lenders may be the next to collapse. However, the Fed’s assessment of the banking system has not changed since its March policy meeting.

Similarly, European Central Bank President Christine Lagarde has stated that the euro area banking sector has proved resilient. Both Powell and Lagarde acknowledged that bank failures could lead to tighter lending conditions, which could potentially result in weakened lending. This could mean that central bankers may not need to be as aggressive in their efforts to control inflation, leading to a likely pause for the Fed and a downshift in the size of rate hikes for the ECB.

For the Fed, that means a likely pause. For the ECB, that means downshifting the size of rate hikes from 50 basis points to 25 basis points. Although officials do not see the recent developments as systemic, traders have ramped up bets that the Fed would pivot to cutting rates this year due to the banking crisis.