The key chart
Change in NFC and HH cost of borrowing since tightening began plotted against months since tightening began (Source: ECB; CMMP)
The key message
ECB policy makers had reasons to pause last month, but they chose not to. The Governing Council raised the three key ECB interest rates by 25bp instead. With subsequent data releases showing a collapse in financing flows to the euro area (EA) private sector and borrowing costs rising at unprecedented rates, they are unlikely to repeat this mistake.
The first leg of monetary policy transmission is to financing conditions i.e. to the volume and cost of credit (the so-called “bank lending channel”). In this, the most aggressive period of policy tightening in the ECB’s history, this leg continues to be very strong. Arguably, too strong.
Cumulative 12-month financing flows to the private sector fell from €782bn in August 2022 to only €16bn in August 2023. This collapse relates to unprecedented increases in the cost of borrowing, among other factors.
The composite cost of borrowing for EA corporates has risen 3.16ppt from 1.83% in June 2022 to 4.99% in August 2023, the highest level since November 2008. For context, during the 2005-08 tightening cycle, this cost rose by only 1.14ppt over the same time-period (14 months) and by only 2.12ppt over the entire 32-month tightening cycle (see key chart above). The household sector displays similar trends but to a lesser degree (as one would expect).
ECB representatives continue to highlight uncertainties regarding the transmission of monetary policy and, specifically, the slower pace of the second leg of transmission to the real economy, which is subject to longer lags.
While this is true, the unique strength of the current first leg of transmission points to elevated risks of policy errors (raising rates too far and/or too fast) and suggests that the appropriate level of restrictive policy has already been reached, if not already exceeded.
Pause for thought – Part II
The first leg of monetary policy transmission is to financing conditions i.e. to the volume and cost of credit (the so-called “bank lending channel”). In this, the most aggressive period of policy tightening in the ECB’s history, this leg continues to be very strong. Arguably, too strong.
Trends in cumulative monthly flows (12 months, EURbn) of loans to the EA private sector (Source: ECB; CMMP)
In earlier posts, I noted how cumulative 12-month financing flows to the private sector fell from €782bn in August 2022 to only €16bn in August 2023 (see chart above). This collapse relates, among other things, to the very rapid rise in the cost of borrowing – the subject of this post.
Trend in composite cost of NFC borrowing (%) (Source: ECB; CMMP)
According to the latest, “Euro area bank interest rate statistics: August 2023” release (4 October 2023), the composite cost of borrowing (COB) for EA corporates (NFCs) has risen 3.16ppt from 1.83% in June 2022 to 4.99% in August 2023, the highest level since November 2008 (see chart above).
For context, during the 2005-08 tightening cycle, the COB for NFCs rose on 1.14ppt over the same time-period (14 months) and by only 2.12ppt over the entire 32-month tightening cycle (see key chart above).
Trend in composite cost of HH borrowing (%) (Source: ECB; CMMP)
The COB for EA households (HHs) has risen 1.88ppt from 1.97% in June 2022 to 3.85% in August 2023, the highest level since August 2011 (see chart above). During the 2005-08 cycle, the COB for HHs rose 0.95ppt over the same period and by only 1.79% over the entire tightening cycle (see key chart above).
Conclusion
ECB representatives continue to highlight uncertainties regarding the transmission of monetary policy and, specifically, the slower pace of the second leg of transmission to the real economy, which is subject to longer lags.
While this is true, the unique strength of the current first leg of transmission points to elevated risks of policy errors (raising rates too far and/or too fast) and suggests that the appropriate level of restrictive policy has already been reached, if not already exceeded.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.