Eurozone Investment Outlook Bleak

Further tightening in credit standards and weakening loan demand from households and businesses in the euro area suggest that the monetary transmission is in play in the real economy, which could prompt the European Central Bank to hit a pause on rate hikes in the coming months though the prospect of high inflation could damp such thoughts.

Results of the January Bank Lending Survey from the ECB, released on Tuesday, revealed a substantial further tightening of credit standards for loans or credit lines to enterprises in the fourth quarter of 2022.

Last week, ECB data showed that the annual growth rate of credit to the private sector – both businesses and households, moderated in October.

“For the ECB, the decline in bank lending for December and the bank lending survey for January together indicate that we see transmission at work now, months ahead of its expected peak in the policy rate,” ING economist Bert Colijn said.

“For the doves on the governing council, this will be a key argument to keep further rate hikes limited from here on, while hawks will focus on stubbornly high core inflation.”

The ECB is widely expected to raise interest rates by 50 basis points this Thursday, and hike them by similar size in March, before hitting a pause.

Eurozone economy narrowly escaped a recession for now, the fourth quarter GDP data released on Tuesday, showed.

The BLS survey showed that net tightening was the biggest since the fourth quarter of 2011 amid the euro area sovereign debt crisis, when 35 percent of banks reported tightening of credit conditions. The latest development was broadly in line with banks’ expectations from the previous survey.

The percentage of banks reporting tighter credit standards shot up to 26 percent in the fourth quarter from 19 percent in the previous three months.
Both small- and medium-enterprises, or SMEs, and large firms faced tightening in credit standards to the same extent.

Risks related to the economic outlook, industry or firm-specific situation and banks’ declining risk tolerance continued to have the largest tightening impact on credit standards, the ECB survey said.

Further, risks related to the collateral demanded, banks’ cost of funds and balance sheet conditions also had a tightening impact on credit standards for loans to euro area firms.

Eurozone banks, 24 percent of them, expect a net tightening of credit standards for loans to firms of a similar magnitude to the current quarter.

The rejection rate for business loans grew in the fourth quarter to 12 percent from 8 percent, consistent with the tighter standards.

Net loan demand for enterprise loans shrunk in the fourth quarter, to -11 percent of banks from 13 percent in the third quarter, marking the first fall since the start of 2021. The decline was also more pronounced than that expected in the previous quarter.

Read more: ECB Rate Hikes Have A Long Way To Go

Falling loan demand signal a bleak outlook for investments in the euro area. Banks indicated a significant negative contribution of the rising general level of interest rates to loan demand and that fixed investment had a further dampening impact on loan demand.

Elevated energy and production costs meant a positive impact of inventories and working capital needs on loan demand from firms. However, the gradual easing of supply bottlenecks in the last quarter of 2022 reduced its contribution compared to the previous two quarters.

Looking ahead, a further fall in loan demand from firms is forecast, -15 percent of banks, for the first quarter, due to a significant decrease in demand for long-term loans.

A strong net tightening of credit standards for home loans, 21 percent of banks, was witnessed in the fourth quarter, but it was less pronounced than the expected 32 percent in the previous quarter.

Banks’ increased risk perceptions primarily drove the observed tightening, while lower risk tolerance and higher cost of funds and balance sheet constraints contributed moderately to the net tightening, the survey said.

Lenders were also concerned about the general economic outlook, borrower creditworthiness and housing market prospects.

This marked the fourth consecutive quarter of both risk perceptions and risk tolerance having a tightening impact, the survey said.

Credit standards for mortgage loans tightened in all the big four euro area countries.

Euro area banks again expect a net tightening of credit standards on loans to households for house purchase, 16 percent, in the first quarter.

Mirroring the tighter credit standards and the pressure on households’ debt servicing capacity from the higher cost of living and rising interest rates, the rejection rates for home loan applications climbed markedly in the euro area.

There was a substantial decrease in the share of banks reporting a decline in demand for home loans, -74 percent versus -42 percent in the previous survey. This is the biggest decrease since the start of the survey.

“Rising interest rates, declining consumer confidence and housing market prospects all contributed strongly towards this substantial fall in demand,” the ECB said.

“Additionally, this marks the second consecutive quarter in which housing market prospects contributed negatively to demand, for the first time since 2013,” the bank added.

In the first quarter of 2023, another strong net decline in the demand for housing loans is expected with net percentage of banks of -49 percent, the survey said.

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