Europe’s banks are pulling back access to credit, and a key measure of inflation in the region has cooled, bolstering the case for the European Central Bank to ease off its aggressive campaign of interest rate hikes when it meets later this week.
Inflation among the 20 countries that use the euro ticked up in April, rising to 7% last month from 6.9% in March, according to an initial estimate released Tuesday by the EU statistics agency.
But core inflation, which strips out volatile food and energy prices, unexpectedly fell to 5.6% from 5.7% — sending a positive signal that inflation, while still elevated, could be improving.
Separately, the ECB indicated in a closely watched report Tuesday that the outlook for lending looks increasingly weak, as higher rates erode demand and banks impose tougher standards on borrowers.
In the first quarter of 2023, net demand for loans to businesses fell the most since the end of 2008, the central bank found after polling 158 banks in the region between March 22 and April 6.
Loans to households that wanted to buy homes also fell steeply, in line with a sharp plunge observed in the last three months of 2022. That drop was the worst since the survey began in 2003.
Meanwhile, banks in the euro area — citing anxiety about the economy and lower appetite for risk — have “substantially” raised their criteria to tap lines of credit or receive loans, according to the ECB.
The survey was the first since the implosion of Silicon Valley Bank in the United States and emergency sale of Switzerland’s Credit Suisse to UBS.
“From a historical perspective, the pace of net tightening in credit standards remained at the highest level since the euro area sovereign debt crisis in 2011,” the ECB said.
Time for a pivot?
The data boosts expectations for the ECB to increase its key interest rate by a quarter of a percentage point when it meets in Frankfurt on Thursday, instead of by half a percentage point.
Investors now put the probability of a quarter-point hike at more than 80%, according to Refinitiv.
But uncertainty about the path the ECB will take remains high. The central bank has made clear that it won’t ease the most intense campaign of rate hikes in its history until it is certain inflation is under control.
“We need to see a sustained decline in core inflation that gives us confidence that our measures are starting to work,” Isabel Schnabel, a top ECB official, said in a recent interview with Politico. “What really matters,” she added, is that inflation recedes to the central bank’s 2% target over the medium term.
At the same time, policymakers want to avoid unnecessary pain from higher borrowing costs, which take time to fully feed through the economy. Europe narrowly dodged a recession over the winter, but economists warn that it’s still at risk, with economic conditions poised to deteriorate in the months ahead.
The survey of lenders shows the hikes implemented to date are having an impact. The ECB has raised its benchmark interest rate at six consecutive meetings since last July. It now stands at 3%.
“Eurozone banks are already generally tightening credit standards and terms and loan demand is decreasing,” Berenberg economist Holger Schmieding said in a note to clients. “The effect of the ECB’s past monetary tightening is unfolding.”