ECB, first pause on rate increases

First pause for the European Central Bank (ECB). After 450 basis points of rate increases, a stop arrives. Which will be temporary, based on the indications of the investment banks. Rates remain stable at 4.50% for the principal and 4.00% for the deposits. President Christine Lagarde, from Athens, did not have too many doubts in outlining the path of the Frankfurt monetary institution. The journey is not yet finished, but it is necessary to evaluate what the best approach is to face future challenges, also in light of the conflict in the Middle East.

Since July 2022 it has been a continuous increase. Ten increases in a row for the cost of money in the euro area. A phenomenon never seen since the single uniform was introduced. The need was to curb the huge increases in prices due to Russia’s brutal invasion of Ukraine. And now we can see the fruits. But precisely for this reason the calibration of the next moves must be precise. In the third quarter of this year there was a further net tightening of the criteria for granting credit to families for the purchase of homes, for consumer credit and for other loans by Eurozone banks. This is what was revealed by the ECB’s “Bank lending survey” in October. For both mortgages and consumer credit, it says, the tightening of credit standards “has largely exceeded previous expectations.” The pace of net tightening for real estate loans, explains the central bank, “even increased compared to the second quarter, while it moderated slightly for consumer credit and other loans”. “The greater perception of risk linked to the economic outlook and the specific situation of the borrower, the lower risk tolerance and the banks’ lower liquidity positions” contributed to the tightening.

The numbers demonstrate the ongoing trend. According to reports from the European Central Bank, the net share of banks reporting restrictions on loan disbursements stood at 12%, compared to 14% in the previous quarter. For the ECB “the tightening accumulated since 2022 has been substantial”. Banking institutions have also reported a further net tightening of the criteria for granting credit to families for the purchase of homes, for consumer credit and for other loans to families (by 11% and 16% respectively) and «in in both cases it greatly exceeded previous expectations.”

Frankfurt’s words are clear. «The Governing Council decided today to keep the ECB’s three key interest rates unchanged. The new information essentially confirmed his previous assessment of the medium-term inflation outlook.” It is still expected that «inflation will remain too high for too long a period of time; furthermore, strong internal pressures on prices persist”. At the same time, “inflation fell sharply in September, partly attributable to strong base effects, and most measures of underlying inflation continued to decline.” Past increases in interest rates decided by the Governing Council “continue to be forcefully transmitted to financing conditions, increasingly slowing down demand and therefore contributing to the reduction of inflation”.

To date, the ECB wants to continue the “journey” towards normalization. Lagarde underlined that “progress in the fight against inflation is progressing well”, but also that the path is narrow. First, because it’s not finished yet. Second, because the euro area economy is seen as stagnating “in the coming quarters”. Precisely for this reason, as Frederik Ducrozet, head of macroeconomic research at Pictet, points out, there will be a lot of caution. “President Lagarde is likely to appear more cautious about growth, if only because of the geopolitical risks,” he explains. “On the other hand, the ECB statement will likely take into account renewed inflationary pressures resulting from rising energy prices,” says Ducrozet. Who then thinks about the next actions. “We expect the ECB to reject any sudden decision to accelerate QT (Quantitative Tightening) in a context of growing macroeconomic, geopolitical and financial uncertainty. Even if the ECB were to opt to end PEPP (Pandemic emergency purchase programme) reinvestments before the end of 2024 as currently planned, this would be largely symbolic and we would expect the ECB to retain the ability to resume flexible interventions in the event of unjustified market tensions”. There is already talk of a first cut, but it is unlikely that this will happen before the second half of 2024.

On the other hand, the position on the Pandemic emergency purchase program (PEPP), the extraordinary program for the purchase of government bonds to deal with the Covid-19 pandemic, is important. “With regard to the PEPP, the Governing Council intends to reinvest the capital repaid on securities maturing under the program until at least the end of 2024,” explains Frankfurt. In any case, “the future gradual reduction of the PEPP portfolio will be managed in such a way as to avoid interference with the appropriate direction of monetary policy”. A factor that could also be decisive for Italy, one of the major beneficiaries of the ECB’s purchasing campaign. Anything can still happen, even in light of geopolitical fibrillations. It is no coincidence, the note specifies, “the Governing Council will continue to flexibly reinvest the capital repaid on the maturing securities of the PEPP portfolio, to counteract the risks to the monetary policy transmission mechanism attributable to the pandemic”. The December meeting will be crucial to understand how the ECB will want to intervene in the event of an escalation of the ongoing fermentations