The ECB: lending rates at the highest since 2008. But Lagarde’s grip does not stop

“Too high, too long”. Inflation continues to bite in the eurozone, according to the latest economic bulletin from the European Central Bank (ECB). Which highlights two aspects in particular. First, that “the outlook for GDP and inflation is very uncertain”. Second, that lending rates are at their highest since 2008. In April, rates reached 4.4% for business loans and 3.4% for mortgage loans. And then the certainty, as explained by the president Christine Lagarde from the Sintra Forum. That is, that new monetary tightening will come. One, for sure, at the end of July. The other, depending on how the price flare-ups go throughout the summer, at the September meeting.

The stagnation has now been evident. The ECB itself explains it. Of course, the recession that was feared for the end of 2022 and the beginning of 2023 was avoided, but the picture is not too much better. “Growth could even be slower if the effects of monetary policy are stronger than expected,” notes the Frankfurt bulletin. The renewed tensions on the financial markets – continues the report – could lead to even more restrictive financing conditions than expected and weaken confidence. In addition, it is noted, “weaker growth in the world economy could further slow down economic activity in the euro area”. However, “growth could be higher than forecasts if the strong labor market and the easing of uncertainty mean greater confidence and higher spending by businesses and households”.

On the macroeconomic front, the situation is evolving. “Economic growth is likely to remain weak in the near term but will strengthen over the course of the year as inflation falls and supply disruptions continue to ease,” it noted. The conditions in the various sectors of the economy, moreover, “are uneven”. The manufacturing sector “continues to weaken, partly due to lower global demand and tighter financing conditions in the euro area”, while services “remain resilient”. And the fears of the Frankfurt institution are gathering precisely on the resilience of this segment. It is the services that could keep inflation high during the summer months, forcing the ECB to increase the cost of money still in view of the autumn.

One of the other temporary certainties, the ECB remarks, is that “the labor market remains a source of strength”. Nearly one million new jobs were added in the first quarter of the year and the unemployment rate settled at an all-time low of 6.5% in April. The average number of hours worked has also increased, although it is still slightly below the pre-pandemic level, Frankfurt economists note.

According to the June 2023 projections, “the economy is expected to return to growth in the coming quarters as energy prices moderate, external demand strengthens and supply bottlenecks are resolved, allowing businesses to continue working with their significant backlogs and uncertainty – including that related to the recent banking sector stress – continues to recede”. Furthermore, he stresses, “real incomes are set to improve, supported by the robust labor market, with unemployment hitting new all-time lows over the projection horizon”. Finally, the raising of awareness: “The tightening of the ECB’s monetary policy will increasingly have repercussions on the real economy”.

What is worrying is the deterioration of credit conditions. An expected element, given the 400 basis points of interest rate hikes from July 2022 to today, but the effects of which have not yet fully transferred directly to households or businesses. An example of this is the following. If it is true that “in April, rates on bank loans to non-financial companies rose to 4.38%, reaching their highest level since 2008”, it is equally true that in April the increases in the cost of money have not yet been incorporated of the last three months. It is therefore possible that there could be a further rise in spreads for households and businesses. At this juncture, as explained several times by Lagarde, the priority is to counter the flare-ups in prices. Which from the energy component have moved to manufacturing and finally, precisely, to services. Where they may last longer than expected.

There are growing fears that it may take longer to counter price flare-ups. “Upside risks to inflation include potential new upward pressures on energy and food costs, including in relation to Russia’s war on Ukraine,” it explains. Not only. “A sustained increase in inflation expectations above the Governing Council’s target, or higher than expected increases in wages or profit margins, could also push inflation up, including in the medium term,” the Bulletin continues. .

Specifically, the pay dynamics are of concern. “Recent wage settlements in several countries have increased the risks of upside inflation. On the other hand, the new tensions on the financial markets could cause inflation to fall faster than expected”, the ECB economists remarked. The weakening of demand, due to a greater transmission of monetary policy, “would also lead to a reduction in pressure on prices, especially in the medium term”. Furthermore, “inflation would fall more rapidly if falling energy prices and smaller increases in food prices were passed on to other goods and services faster than currently projected.”

One year after the first rate hike, Lagarde’s “journey” is not over yet. As, indeed, he admitted. Indeed, it risks becoming more difficult, given that in the Governing Council there are countries such as Luxembourg, which has inflation at 2%, and others such as Latvia and Slovakia, which are a few decimal places above 12%. Finally, economies, such as the Italian one, which are experiencing significant persistence of core inflation, net of energy and food. Differences that could lead to wide disagreements during the autumn meetings in Frankfurt. Just the opposite of the collegiality that Lagarde asks of her colleagues every time.