Groceries are ridiculously expensive; mortgages are harder to get; interest rates will continue going up before they come down.
The European Central Bank raised interest rates 25 points on Thursday, May 4th, on the heels of two reports—a quarterly bank survey that showed banks have tightened lending, and Eurostat’s monthly inflation report.
“Headline inflation has declined over recent months, but underlying price pressures remain strong. At the same time, the past rate increases are being transmitted forcefully to euro area financing and monetary conditions, while the lags and strength of transmission to the real economy remain uncertain,” the ECB said in a statement, showing both reports had been taken into account in the decision to raise interest rates.
The Eurostat data released at the beginning of May showed that core inflation in the euro zone, which doesn’t account for volatile food and energy components, dropped in April, the first decline in 10 months. The drop was a mere tenth of a percent, edging down to 5.6% from 5.7 % in March, but it has sparked hopes that the inflation spike that took off last year has peaked.
Economists had largely expected the slight fluctuation down, as well as the slight rise in headline inflation—which accounts for food and electricity prices—back up to 7.0% due to strong food and service prices. The strength of core inflation is still over twice the economically desirable 2%, meaning another interest rate hike is to be expected.
In line with interest rate hikes, the ECB’s survey of banks for the first quarter of 2023 showed that they are more reluctant to lend, whether to companies or individuals. Housing loans especially have become harder to get.
“Banks also reported a further substantial net tightening of credit standards for housing loans in the first quarter of 2023, while the net tightening became less pronounced for consumer credit,” the report explained.
Regarding banks’ stance on lending to companies, “the tightening was stronger than banks had expected in the previous quarter.”
The survey also found that banks are not only pickier about what enterprises they give loans to but are also receiving fewer requests for credit from companies.
Overall, it’s the fastest tightening in lending since 2011, according to the ECB. The trend of stricter lending conditions is expected to continue for the next three months.
Economists polled by Reuters were generally expecting to see a 25 basis point rise to 3.25%, though a higher hike to 3.50% is also on the table. Bloomberg also reports that economists are predicting this interest hike plus two more for the eurozone before interest rates stabilise and possibly drop later in the year, as our Fiscal Forecast Europe said in mid-April. Rates will peak at 3.6%, some economists predict.
A modest growth in the EU’s services sector, which accounts for the bulk of its economic activity, may keep core inflation and wage pressures elevated, meaning the ECB will continue to raise interest rates in an attempt to tamp down the inflation.
If workers successfully demand that wages keep up with the cost of living, as civil servants in Germany have recently done, it may keep inflation inflamed longer than hoped.
“Tight labour markets are supporting worker and union bargaining power,” Patrick Saner, head of macro strategy at Swiss Re, told Reuters. “Whilst we view a 1970s wage-price spiral as unlikely, recent labour market developments must for sure be concerning for the ECB as it keeps the risk of a spiral simmering.”
With wages still lagging behind the cost of living and with credit tight, problems that have become almost chronic in some regions (such as affordable housing), will remain hard to resolve.
