Financial markets finally enjoyed a somewhat quiet week again, with no further banks collapsing and market stress receding. Borrowing from the Fed’s discount window stood at ‘just’ $88 billion on 29 March, down from $110 billion a week ago.

So, thus far, the ECB’s base case that the market turmoil would prove to be fleeting and would not affect Eurozone banks, seems to be unfolding, paving the way for further rate hikes. Indeed, arguably, the banking stress aided central banks to some extent: it raised risk premia and, hence, banks’ cost of funding, which may have forced banks to tighten their credit standards and reduce their new lending. In other words, market conditions may amplify the ECB’s policy stance. As long as this happens in a gradual and predictable manner, this tightening of bank lending is desirable. However, the recent turmoil around the global banking sector suggests that this process may not always be so linear.

With cooler heads prevailing, that (hand) brake on credit provision has been lifted. So that leaves more tightening for the ECB, right? Indeed, the inflation data for March suggest as much. The available data for the euro area member states paint a picture of visibly retreating headline inflation. Yet, core readings remain stickier.

That said, the ECB – and other central banks for that matter – have to become more cautious. Not only because market stress could resurface, but also because data indicate that bank lending was already slowing prior to the episode of market stress. In fact, we estimate that the euro area credit impulse is now just marginally above zero. This is generally a premonition of slower consumption and investment spending. Again, that is currently desired by the central banks as they seek to dampen domestic demand; but if this credit impulse turns significantly negative, a deeper recession could be the result. Bloomberg Economics estimates that the US credit impulse had already turned negative by the end of last year. In short, central banks are still at risk of doing too little; but the risk of doing too much is clearly growing with each hike.

And whereas the ECB may have been right to assume that banking turmoil would be fleeting, their baseline growth forecasts may well miss the mark. They may be overly reliant on the assumption that trade with China would pick up significantly. That’s not just our words, a former senior official from the French central bank called these forecasts “heroic”. And it’s easy to see how a much less optimistic scenario could unfold.

The Wall Street Journal reported yesterday that chip makers may be forced to choose between the US and China. And why stop at chips? The US Treasury department will release more guidance on the Inflation Reduction Act today. Its aims have been clear for some time, but this think-tank report summarizes it well: “to generate new, globally distributed critical mineral supply chains that are not dependent on the Chinese Communist Party to access the building blocks of a more electrified, connected, and autonomous future.” Such attempts to reduce China’s stranglehold on e.g. the electric vehicles and clean-tech sectors will obviously increase global competition over key minerals and resources.

Europe will also closely watch these details of the Inflation Reduction Act, and to what extent it will hit the continent’s manufacturing. Earlier this week, the FT reported that, according to people with knowledge of the talks, Washington has offered to make cobalt, graphite, lithium, manganese and nickel, eligible for subsidies under its IRA, if they are mined or processed in the EU. But it remains questionable as to how much value this offer has in the eyes of European policy makers, as it will be a long time before increased mining capacity comes on stream on the European continent. Plus, the production and/or assembly of batteries and cars (the ‘value added part’ in the supply chain) still is required to take place in the US, Canada or Mexico.

Moreover, this US-China decoupling may force Europe to choose sides sooner rather than later. Indeed, the US has been pushing its allies to toughen their stance towards China. And the Netherlands have effectively already done so, when they followed the US in banning the export of certain semiconductor technology earlier this year. China’s ambassador to the EU threatened the bloc not to cut trade ties with China.

EC President Von der Leyen has refuted that Europe should ‘decouple’ from China, but did tell the bloc to start ‘de-risking’ in dealing with the country. That does not sound like the rejuvenation of close trade ties. De-globalization comes in many facets, but for the EU it may not so much stem from increased autonomy in the short-term (which, at least, would also have benefits for the domestic economy), but rather a more generic reduction of trade, as the US tightens the reins on China. That’s a losing business model for Europe.