Signature Bank, New York, was shut down by regulators

There is a saying that today’s news is tomorrow’s fish and chip paper, which basically means that what is all the rage today will be forgotten about tomorrow and will only be fit for stopping your dinner (the fish and chips) from falling in your lap.

Up until last Friday it was inflation that was all the rage and how central banks were going to tighten monetary policy in order to bring it back to target. But now we seem to be finding out that the lagged effects from rate hikes that started a year, or more, ago for many are starting to come through. This might be reflected in the fall in annual inflation rates to some extent but clearly the biggest lagged effect now seems to be the weakness of banks.

Should this weakness in the banking sector undermine growth, then inflation seems likely to fall, and possibly quite fast. As a result, rate hikes now from the likes of the Fed or ECB could prove to be a case of fighting the old battle; not the current one. The ECB has form on this one. Fifteen years ago, in the middle of 2008 when the global financial crisis was already developing (remember Bear Stearns failed in March 2008), the ECB hiked rates in response to an (imaginary) inflation threat and soon had to reverse its actions. Fast-forward to 2011 when the Euro zone debt crisis was well under way (remember the first bailout measures were undertaken in May 2010), and the ECB hiked rates again – twice. Then, as in 2008, the subsequent economic implosion rendered the rise in inflation in 2011 as marginal and temporary.

Once again, the ECB was forced to reverse these cuts very soon and, once again the ECB was left with a fair amount of egg on its face. Back in the summer of 2008 the ECB argued that it was the US banking system that was under pressure; something which apparently gave it licence to push on with the summer-2008 rate hike. Eventually, of course, it was clear that euro zone could avoid the fallout even if its banks were not as vulnerable as those in the US. If we come back to today, there’s been a quick reminder of European banking woes, even if the bank concerned, Credit Suisse lies outside the euro zone.

The question now is not just whether central banks like the ECB and Fed may pause rate hikes on the basis that they don’t want to inflame banking strains; but also, whether they believe that the consequences of this crisis will crash economies and inflation and so turn any pause in hikes into a permanent cessation.

In many ways we hope that this is what happens. But that requires a lot of foresight and there’s still a danger in our view that the central banks – particularly the ECB – will want to ‘finish off’ the old enemy (inflation) rather than start to tackle the new foe (banking implosion).

In fairness, one argument for keeping going with rate hikes, even in the face of current tensions, is that the banks’ can’t be sure that the strains will produce permanent disinflationary pressure or just a temporary cessation. There are still all the problems of supply chain disturbances, for instance, that could actually be made much worse if credit flows to firms engaged in supply chains slows down. Labour markets are still tight and will probably still be even if growth wilts under the pressure from banking strains.

“What was always looking like a tough gig for central banks has just got a lot more difficult. What’s more, we see a real risk that, whatever they decide, the market will believe that they are wrong and financial market pressure will intensify. Hence, for now at least we continue to stick to the call we’ve had for some time now that the dollar will rise and risk assets will fall”, Colin, FX analyst said.