So the ECB has now joined others such as Poland and Sweden in raising interest rates to combat inflation.
Some fear that this may threaten what is clearly still a fragile economic recovery. In our view however it is unlikely to have a significant short term impact on growth. For one thing it has been widely expected and sign-posted – one of the more appreciated hallmarks of ECB moves!
Equally, it needs to be remembered that increases in the policy rate should be offset to some degree by a fall in bank margins. Over recent times the spreads between policy rates and the rates at which banks actually lend have been falling but they are still historically high. We may not see a return to the margins typical before the crisis, with banks now reliant on more expensive retail rather than wholesale funding and the stricter capital adequacy requirements of Basle III impacting, but a steady fall in risk aversion and increased competition should still result in a further fall in lending margins.
The spread between ECB policy rates and commercial lending rates
Cushman & Wakefield, European Research Group
What’s more, market expectations that EZ rates may climb 100-150bp in the next year may yet prove too aggressive, with a more cautious pattern of increases just as likely. However, while policy tightening may not have the impact some fear, it will have more adverse effects on some. Eurozone countries who are struggling with excess sovereign and private sector debt will not welcome the increase for example but it will also raise tough questions for countries outside the Eurozone who can leave rates unchanged and hence gain a currency advantage but may also risk the sustainability of their debt burden for those carrying an excess of foreign currency debt.
Overall, while the impact will not be uniform and interest rate increases, however slow, will hit borrowers, they will also signal that we are heading back to more “normal” times. And perhaps that return to normality will be the biggest boost for confidence and activity that we can hope for!
David Hutchings, European Research Group, London