Caught between high inflation and banking fears, the European Central Bank has taken the most perilous route out. Frankfurt policymakers pointed to stubbornly high consumer prices as the reason for sticking to their planned 50 basis point increase in the deposit rate to 3%.

Financial instability and a slowing economy may soon persuade them to take a milder path.

During her press conference, ECB President Christine Lagarde could hardly distinguish between the institution’s two main duties: fighting inflation and ensuring financial stability.

On the first point, the central bank now expects consumer prices excluding energy and food to grow 4.6% in 2023, more than double its 2% target and higher than the 4.2% forecast in December.

On the second point, Lagarde praised the banking reforms implemented since the 2008 financial crisis, stressed that there was no liquidity shortage among Europe’s lenders, and said the ECB was ready to dip into its large “toolbox” should one arise.

Two major central banks – the U.S. Federal Reserve and the Swiss National Bank – have had to take action to stave off a wider banking crisis in less than a week, but the ECB’s message was clear. At the moment, slaying inflation is more important than helping banks.

But the monetary tightening that has taken the deposit rate to its highest level since 2008 in eight months will pull down euro zone growth in 2024 and 2025.

Lagarde confirmed that, saying the big jump in rates is starting to be felt in the real economy, from dearer mortgages to tighter lending to firms.

The ECB has revised down its growth projections for 2024 and 2025 to 1.6% in both years, compared to the December forecast of 1.9% in 2024 and 1.8% in 2025.

Even if that doesn’t lead to a ruinous failure, further banking stress would exacerbate that deceleration as more lenders batten down the hatches, starving the economy of credit.

European bank stocks’ muted reaction to the rate hike, and the fact that the next decision is not due until May, buys the ECB some time to ponder dialling down its rate hiking zeal.

But, today’s decisions illustrate that the ECB is no longer the unconditional lender of last resort for the eurozone. Since the financial crisis in 2007 and 2008, financial markets have gotten used to the idea that central banks will always play the lender of last resort.

In a European context, be it a financial crisis, a euro crisis or a pandemic, the ECB has always been there to help. “Whatever it takes”, if needed.

All in all, today’s decision and communication leave the door open to heated debates at the next meetings. It should be clear that with any further rate hike the risk that something breaks increases. Therefore, today’s decisions could mark the start of the final phase of the ECB’s tightening cycle: a slowdown in the pace, size and number of any further rate hikes.