ECB’s Bank Lending Survey clearly shows contraction in credit supply and demand

ECB buying corporate

Peter Goves (MFS Investment Management)| We believe ECB policy rates have most likely peaked for this cycle. This argument is based on three pillars: growth dynamics, the inflation outlook and what the ECB itself is communicating.

On growth, the euro area is currently operating in a quasi-recessionary environment. Although we don’t technically have two quarters of negative GDP prints, Q3 growth was -0.1% and below ECB expectations. The vast majority of indicators we assess (PMIs, IFO, ESI, consumer confidence) continue to paint a subdued picture for near-term economic activity. The ECB currently sees growth at 0.7% in 2023 and 1.0% in 2024. We believe risks here are to the downside.

On inflation, base effects are currently exerting downward pressure on headline HICP and may continue to deliver some volatility near-term. Over the medium term, further downward inflationary pressure is plausible should the economy be operating below potential. With inflation falling, it is harder to argue for further hikes in our view. Of course, this outlook is predicated on the absence of another inflation shock or the labour market tightening.

Thirdly, let’s consider what the ECB is actually saying. The latest guidance is clear that rates held at “current levels” will have a “substantial” effect in getting inflation to target. We translate this into a preference to hold rates where they are rather than keep hiking. Rates are already demonstrably restrictive. We claim this with reference to the ECB’s Bank Lending Survey which clearly shows contraction in credit supply and credit demand.

Consequently, we believe that prevailing rates will continue to dampen demand and therefore help push inflation down to target. How long this will take is an open question, especially since there are few ECB cycles to study. What we do suspect is that if there were to be a sustained inflation undershoot, then rate cuts could come onto the table earlier than currently priced.

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