Lending slowdown will end the rate hike cycle

Photographer: MPI/Archive Photos/Bloomberg

Central Banks are on the verge of declaring the yearlong interest-rate hiking cycle over. The reason: Banks have taken the wheel and are pressing the brakes.

Federal Reserve Chair Jerome Powell laid the groundwork at his March 22 FOMC press conference. When asked about tightening credit conditions, he responded, "we think it's potentially quite real and that argues for being alert as we go forward, as we think about further rate hikes for us, we'll be paying attention." That's code for clear evidence that policymakers expect tighter financial conditions to replace the blunt instrument they've wielded for the past year or so.

As night follows day, higher interest-rate costs are putting potential corporate and private borrowers off, and many are repaying back debt if possible. While the global banking system remains awash in liquidity -- and central banks have already fallen over themselves to keep the taps fully open — a worrisome scare over bank deposit security and a reluctance to take on debt constitute the makings of a credit crunch.

The signs will soon start emerging. Next week, we get the Bank of England  credit conditions survey, and a month later its quarterly monetary policy review. The end-2022 summary showed UK lenders the most wary since the global financial crisis. The European Central Bank's quarterly bank-lending survey is due toward the end of April, sufficiently ahead of its May 4 gathering. The January report showed euro loan growth turning negative in some southern countries. The next Fed Senior Loan officer Survey is not due until May 8, almost a week after the FOMC meeting, but policymakers will have a comprehensive overview of its likely conclusions.

As my colleague Paul Davies wrote last month following three US bank failures,  "at a certain point, bank stability is monetary policy...tightening is accelerating like a slingshot through the banking system. Like an elastic band it stretches until it snaps back all at once."  The collapse of Credit Suisse Group AG into UBS Group AG's arms has emphasized problems with bank balance sheets is not a localized US problem. Daniel Kral, senior economist at Oxford Economics, tweeted that the last time credit flow dropped this sharply was during the euro crisis a decade ago.

Right on cue, the ECB has warned of real estate risks in its macroprudential bulletin. Perhaps something it ought to have been more aware of as the net asset value of commercial property investment funds has tripled over the past decade to over €1 trillion. Bloomberg credit reporter Tasos Vossos points out that the majority of investment-grade real-estate corporate debt is trading at high yield levels. The average coupon is just under 1.6% on property-related euro-denominated debt, a Bloomberg index shows. But the cost to replace equivalent debt in current market conditions is around 5%. There is the rub, as property is about as interest-rate sensitive a business as it gets.

Overall lending in the euro area dipped to 4.3% in February from 4.7% the month prior. Corporate lending growth has nearly halved over the past quarter from over 8%. It is close to turning negative in Italy. Note this was the situation before the recent banking crisis unfolded.

The UK is suffering from a similar plight. According to Deutsche Bank AG analysts, total lending as a share of gross domestic product dropped to 0.5% in February – its lowest reading since 2013. It is not just in household mortgage lending where the pinch of higher rates is being felt. There is a clear slowdown in overall borrowing. For a second consecutive month, corporates have continued to repay loans. Bloomberg Economics estimates the recent rise in credit spreads is equivalent to a little bit more than a 25 basis point hike, and thereby expects the BOE to hold on rates in May.  

Continuing to hike interest rates into these banking headwinds would be a serious misjudgment by policymakers, especially as year-end headline inflation forecasts point to a significant slowdown. It is hardly a revelation that stickier core prices excluding food and energy remain well above their 2% target. It took a longer time to get up there; so it will be to fall. But surely it is not beyond the wit of our monetary overlords to look through this before the economic infrastructure collapses. The price for pausing seems the least costly.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Previously, he was chief markets strategist for Haitong Securities in London.

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.