Instead, we think the European Central Bank (ECB) and Federal Reserve will go as far as possible to distinguish their inflation-fighting campaigns from measures to deal with bank troubles and safeguard the financial system. The financial cracks are unlikely to deter central banks from trying to get inflation back closer to their targets. The trade-off for central banks – between fighting inflation and protecting both economic activity and financial stability – is now clear and immediate. We think that’s misguided and expect major central banks to keep hiking rates in their meetings in coming days to try to rein in persistent inflation. Markets have slashed their expectations of interest rate paths, expecting central banks to come to the economy’s rescue by cutting rates as they used to do in episodes of financial stress. The cases are different – but markets clearly are looking at bank vulnerabilities through a new, high-interest rate lens.

The latest cracks have appeared in the banking sector on both sides of the Atlantic. Markets have woken up to the damage caused by that approach – a recession foretold – and are starting to price it in. The market gyrations of the past week are not rooted in a banking crisis, in our view, but rather are evidence of financial cracks resulting from the fastest interest rate hike campaigns since the early 1980s.

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