One of the key passages of the section dedicated to Western Europe within the latest IMF’s World Economic Outlook reads “growth is also likely to be affected by tighter availability of bank credit”. Again, when commenting about heightened downside risks to growth, the Fund clearly states “Deteriorating conditions in credit markets could further slow consumption and investment, particularly if banks sharply curtail lending in the coming quarters…”.
The recent ECB Bank Lending Survey (published on October 8, cut-off date: 27 September, one month longer than the usual schedule) vindicates such a view. The overall picture that emerges is one of tighter credit standards, both for loans to enterprises and housing loans to households. To the contrary, consumer credit witnesses a net easing of standards.
SHARP TIGHTENING IN CREDIT STANDARDS
What worries me the most is the degree of tightening that banks see likely to affect corporate lending. After a prolonged period of (too?) easy credit standards, banks began to ration credit as soon as the market crisis erupted. At +31 (from –3 in July), the balance measuring the difference between the share of banks reporting tighter standards and those reporting easier standards climbed to its highest level since mid-2003. The worsened macro (global economy) and micro (specific firm) outlook induced a massive re-appraisal of risk that is bound to weigh on capital expenditure growth over next quarters. On the positive side, one has to acknowledge that the plunge in M&A and corporate restructuring were the main culprits for the decline in net loan demand – which remained slightly positive – and that loan demand for fixed investment remains close to its cyclical peak hit at the beginning of 2007.
SLOWING LOAN DEMAND HINTS AT SOFTER FIXED INVESTMENT
Nonetheless, even dismissing the hypothesis of a seizing up credit channel with the consequent plunge in demand – keep in mind that firms have recorded massive cash flows over recent years and their leverage remains low by any historical standards -, it is easy to gauge that a (hopefully gentle) slowdown in fixed investment next year is in the cards.
This survey has to be considered a sort of special issue. In order to evaluate the consequences of the financial crisis, the cut-off date has been postponed so that the observed period is almost one month longer than the usual, and an ad hoc section on the crisis’ impact was added. As expected, banks reported difficulties in accessing wholesale funding, and a major fallout in securitisation on mortgages and corporate loans. What appears more important, though, is that respondent banks generally expect recent events to influence credit standards more in Q4 2007 than was seen over the previous quarter. This means we may have not seen the worst yet in terms of credit rationing and that overall growth will likely hit a soft patch a the turn of the year.
Despite most of the Council members keep playing a hawkish note, the last being Weber who has recently said that given upside risks to inflation “it is too early to reject further policy response”, the ECB is well aware that a potential seize-up in the credit channel is the main risk the real economy is currently running. This holds true especially at a time when the long-awaited acceleration in private consumption, expected to take the baton of growth engine from investment, is threatened by the housing market correction in those countries – France, Ireland, Spain – where either house price stay elevated or the elasticity of household demand to rising interest rates is not negligible.
Like anybody else, the ECB was already expecting for next year a mild deceleration in investments after the roaring 2006-2007. Clearly, chances that such easing may turn sour have stepped up, as well as the probability that private consumption will fail to accelerate from the recent subdued figures. If households are no longer able to borrow at affordable rates, with the housing market under pressure and confidence hit by recent gloomy news on the financial sector’s performance, the probabilities to see a decline in the savings rate because of an increased willingness to spend are, admittedly, modest. We remain optimistic on outlays’ prospects in the wake of ongoing labour market strength, but we are aware that a steep rise in consumption’s contribution to growth is not in the cards. Some tough times lie ahead for the euro area.