The key chart
Changes in COB (ppt) since tightening began plotted against months since tightening began (Source: ECB; CMMP)
The key message
With the uniquely rapid “pass through” of monetary policy leading to a sharp slowdown in financing flows to the euro area private sector, the ECB has reasons to pause this month – but that doesn’t mean that it will.
Pause for thought
In a recent post, I highlighted the sharp slowdown in financing flows to the euro area (EA) private sector and the causal link to the relatively rapid pass through of ECB policy to the cost of borrowing for EA corporates (NFCs) and, to a lesser extent, the cost of borrowing for EA households (HHs).
This link was confirmed by Isabel Schnabel, a Member of the Executive Board of the ECB, in a speech on 31 August 2023.
“Bank lending flows to both firms and households have dropped sharply in recent months as banks have increased their lending rates and tightened their credit standards. Our bank lending survey confirms that the level of interest rates is a key reason behind the contraction in loan demand.”
Schnabel, 31 August 2023
The release of EA bank interest rate statistics for July 2023 on 1 September 2023 provided further evidence of the unique pace of increase in the cost of borrowing.
Trend in CCOB for NFCs since July 2008 (Source: ECB; CMMP)
The composite cost of borrowing (CCOB) for NFCs has risen 3.10ppt from 1.83% in June 2022 to 4.93% in July 2023, its highest level since November 2008 (see chart above).
The rate of increase is a defining feature of the current tightening cycle.
During the 2005-08 tightening cycle, the CCOB for NFCs rose only 1.12ppt over the same time period (13 months), and only 2.12ppt over the entire 32 month tightening period (see key chart above).
Trend in CCOB for HHs since July 2008 (Source: ECB; CMMP)
The CCOB for HHs has risen 1.78ppt from 1.97% in June 2022 to 3.75% in July 2023, its highest level since February 2012. During the 2005-08 tightening period, the CCOB for HHs rose 0.88ppt over the same time period (13 months) and 1.79ppt over the entire 32 month tightening period.
According to the most recent “Bank Lending Survey”, credit standards, particularly for loans to NFCs, are expected to tighten further in the coming months, albeit at a slower pause. The ECB also “expects the lagged effect of past policy rates to continue to dampen aggregate spending” (Schnabel, 31 August 2023).
Conclusion
In short, the ECB has reasons to pause this month but as conflicting assessments from Pierre Wunsch (a bit more probably needed) on 2 September 2023 and Mario Centeno (danger of doing too much) on 4 September 2023 suggest, that does not meant that they will.
“The lack of a historical precedent means that we can rely less on past experience”
(Schnabel, 31 August 2023)
As noted in previous posts, the ECB lacks a playbook for the most rapid period of monetary tightening in its history. The rapid pace of adjustment in financing flows experienced to date suggests that the risks of policy errors are rising rapidly with negative, potential impacts on the region’s future growth prospects.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.