Silver Dives While Central Banks Double Down

The same moves by two central banks, the Fed and the ECB, should have different impact on the precious metals. This time, however, one took the lead.

The Federal Reserve is perhaps the most important central bank in the world, but let’s also see what the European Central Bank did this week. The central bank of the eurozone announced quantitative tightening from March 2023 and increased the interest rates by 50 basis points:

The Governing Council today decided to raise the three key ECB interest rates by 50 basis points and, based on the substantial upward revision to the inflation outlook, expects to raise them further.

It was the fourth hike in a row. Earlier this year, the ECB raised the rates by 50 basis points from negative 0.5% to 0%, and then two times by 75 basis points to 1.5%. The last move took the deposit facility rate to 2%, the refinancing rate to 2.5%, and the marginal lending to 2.75% - a level not seen in fourteen years.

Given how ultra-dovish the ECB usually is, it has been raising rates at an unprecedented pace this year. However, this hike marks a slowdown in the pace of tightening compared to the last two 75-basis points increases. It’s quite understandable given that a recession is coming. The problem is that the ECB started its tightening cycle very late, so it simply had a narrower window for hawkish moves. What’s important, the recessionary forecast is now not only my guess, but it’s the official view of the ECB:

Staff now expects a short-lived and shallow recession in the euro area at the turn of the year.

EBC Signals More Hikes Are Coming

On the other hand, the ECB declared that rates would be increased further:

we judged that interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive, to ensure a timely return of inflation to our 2% medium-term target.

It makes perfect sense, given the substantial upward revision to the inflation outlook. Compared with the September 2022 projections, headline inflation has been revised up substantially for 2023 (from 5.5% to 6.3%) and 2024 (from 2.3% to 3.4%). Hence, although inflation shows some signs of peaking, it’s expected to be more persistent. However, some analysts say that Christine Lagarde had to pledge more hikes to secure a majority for the slowdown in the pace of monetary policy tightening. During the press conference, she said:

Based on the information that we have available today, that predicates another 50-basis-point rate hike at our next meeting, and possibly at the one after that, and possibly thereafter, but everything will also be determined by the review of data. So don’t assume that it’s a one-shot 50; it’s more than that.

Implications for Silver

What do ECB’s last decisions imply for the silver market? Well, from the fundamental point of view, a hawkish ECB and the promise of further hikes should be positive for silver and gold prices. After the monetary policy statement, the expected peak in the ECB’s deposit rate increased from 2.75% to just over 3%. Such hawkish expectations should strengthen the euro against the dollar, which should be positive for the precious metals.

However, as the chart below shows, the price of silver declined yesterday. What happened?

Well, the ECB didn’t raise interest rates in vain only one day after the Fed’s move. Apparently, the U.S. central bank remains still relatively more hawkish than its European counterpart. This is, of course, bad news for the precious metals. However, it seems to be already priced in the silver prices. And the fact that both major central banks have already slowed down the pace of monetary tightening should set the stage for the next rally in the precious metals.

Arkadiusz Sieron, PhD