Eurozone BLS and inflation allows ECB to slow down to a 25bp hike

Euro Macro: Banks’ credit standards tighten further

The ECB Bank Lending Survey (BLS) for 2023Q1 showed that eurozone banks further tightened credit standards on all types of loans. The net percentage of banks that tightened credit standards for loans to companies stabilised at 27, which was higher than banks had forecast themselves a quarter ago, and also the highest level since the eurozone crisis. The share of rejected applications for loans to firms increased further (net percentage 15 in Q1, up from 12 in 2022Q4).

Meanwhile, net demand for loans by companies (balance higher minus lower) plummeted to -38, down from -12 in Q4, recording its sharpest decline since 2009Q1. Banks also reported a sharp further tightening in credit standards on loans to households for house purchases (net tightening 19 after 21 in 2022Q4), while demand for these loans also dropped further (balance of higher demand and lower demand -72 in Q1 after -74 in Q4).

All in all, the results of the BLS clearly show that the economy is increasingly feeling the negative consequences of the aggressive interest rate hikes by the ECB since the middle of last year, which tend to impact the economy with a considerable lag. The results of the BLS support our base scenario for the eurozone economy of modest contractions in GDP during the rest of the year.

Eurozone inflation rises slightly, but core edges lower

Eurozone inflation increased to 7.0% in April, up from 6.9% in March, whereas the core rate (excluding food, energy, alcohol and tobacco) declined to 5.6%, down from 5.7% in March. The rise in inflation in April, was largely due to higher energy price inflation, which bounced back to 2.5% in April after it plummeted to -0.9% in March. The rise in energy price inflation in April probably is only temporary as it results from base effects caused by changes in energy prices in the first months after the start of the war in Ukraine in February 2022. We expect energy price inflation to start fall again in the coming months and to move to levels well below zero in the second half of this year. Food price inflation declined in April (to 13.6%, from 15.5% in March). Changes in commodity and wholesale prices indicate that food price inflation should fall further in the coming months.

Within core inflation, non-energy industrial goods price inflation fell to 6.2% in April, down from 6.6% in March. The clearing of global supply bottlenecks and the phasing out of the pass through of past rises in energy costs by producers probably played a role in the decline in the inflation rate of industrial goods. This trend should also continue in the coming months. Finally services sector inflation did not yet embark on a downward trajectory, but increased to 5.2% in April, up from 5.1% in March. Services prices are to a relatively large extent driven by wage growth, which still seems to be rising due to sectoral labour shortages that emerged after the pandemic. We think that services inflation could remain elevated for a while, but that it should fall in the course of the year, as the expected economic slowdown and rise in unemployment should reduce wage growth in the second half of this year and also reduce services sector inflation.

All in all, we expect headline inflation to drop faster than the core rate this year, with the headline falling below the core rate as from the middle of the year onwards. By the end of the year, the headline inflation rate should be around 2%, whereas core inflation is expected to be around 3%.