Bank stress brings US closer to recession, says Kashkari

WASHINGTON/FRANKFURT, March 26 (Reuters) – Stress in the banking sector is being watched closely for its potential to trigger a credit crunch, a U.S. central bank policymaker said on Sunday, as a European Central Bank official also flagged a possible tightening of lending . .

Authorities around the world are on high alert for the fallout from recent banking turmoil following the collapse in the United States of Silicon Valley Bank (SVB) and Signature Bank (SBNY.O) and the bailout a week ago of Credit Suisse (CSGN).S).

Last week ended with indicators of financial market stress flashing. The euro fell against the dollar, yields on eurozone government bonds fell and the cost of insuring against bank defaults rose despite assurances from policymakers.

In the latest attempt to reassure investors, the US Treasury Department said on Friday that the Financial Stability Oversight Council agreed that the US banking system is “sound and resilient”.

“What’s unclear to us is how much of these bank strains lead to a widespread credit crunch. That credit crunch … would then slow down the economy. This is something we’re watching very, very closely,” Minneapolis Fed President Neel Kashkari said Sunday on the CBS show “Face the Nation.”

“It definitely brings us closer,” said Kashkari, who has been among the most hawkish Fed policymakers in advocating higher interest rates to fight inflation.

He said it was too early to gauge the “imprint” banking stress would have on the economy and therefore too early to know how it might affect the next rate decision by the Federal Open Market Committee (FOMC).

Meanwhile in Europe, the ECB believes recent banking sector turmoil could lead to lower growth and inflation rates, its vice president Luis de Guindos said.

“Our impression is that they will lead to a further tightening of credit standards in the euro area. And perhaps this will feed through to the economy in the form of lower growth and lower inflation,” he told the Business Post.

‘CONCERNING SIGNS’

After the Swiss government engineered the rescue takeover of Credit Suisse by Zurich-based rival UBS ( UBSG.S ), Germany’s Deutsche Bank ( DBKGn.DE ) moved into the investor spotlight.

Shares in Germany’s biggest bank fell 8.5% on Friday, as the cost of insuring the bonds against the risk of default rose sharply and the index of European bank shares (.SX7P) fell.

The sudden increase in stress for banks has raised questions about whether major central banks will continue to pursue aggressive rate hikes to try to bring down inflation, and has led some to speculate on when interest rates will begin to fall.

Erik Nielsen, group financial adviser at UniCredit in London, said central banks should not separate monetary policy from financial stability at a time of heightened fears that banking problems could lead to a widespread financial crisis.

“Major central banks, including the Fed and ECB, should issue a joint statement that any further interest rate hikes are off the table at least until stability has returned to financial markets,” Nielsen said in a note on Sunday.

The Fed raised interest rates a quarter of a point this week, but left the door open to halting further hikes until it is clear how bank lending practices may change following the recent collapse of SVB and New York-based Signature Bank.

“There are some worrying signs. On the positive side, deposit outflows seem to have slowed down. Some confidence is being restored among smaller and regional banks,” Kashkari said.

Turbulence among bank stocks on both sides of the Atlantic continued until the end of the week, despite efforts by politicians, central banks and regulators to allay concerns.

“We’ve seen that the capital markets have largely been closed for the last two weeks. If those capital markets remain closed because borrowers and lenders remain nervous, that would tell me, okay, this is likely to have a bigger impact on the economy,” Kashkari said, adding to: “So it’s too early to make any forecasts about the next FOMC meeting.”

The Fed has rolled out an emergency lending program meant to keep other regional lenders out of trouble. Recent data showed money moving from smaller to larger banks in the days after SVB’s collapse on March 10, although Fed Chairman Jerome Powell said last week he believed the situation had “stabilised”.

Reporting by Howard Schneider, Tom Sims and Davide Barbuscia; Author of Alexander Smith; Editing by Cynthia Osterman

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