Alpha Bank analysis: Rising interest rate cycle, investment and credit expansion in the Eurozone

The increase in interest rates by the European Central Bank (ECB) by half a percentage point – its first increase in more than a decade – marks the first move away from the policy of pursuing unconventional monetary policy, Alpha Bank economic analysts point out , in the bank’s weekly financial report.

The ECB’s move, the bank’s analysts say among other things, was dictated by the need to compress inflationary expectations in the Eurozone and support the single currency’s exchange rate, as it has depreciated against the US dollar and has been trading in recent days close to the absolute rate of 1/1 .

In this context, the question that arises is whether the increase in interest rates, and therefore the tightening of financing conditions, could weaken the incentives to implement investment projects, limiting the demand for loans and, consequently, credit expansion in the zone of euro (ZtE). On the supply side, European banks are in better financial shape (higher profitability, improved capital adequacy ratios, portfolio quality), compared to the sovereign debt crisis of the previous decade. However, the ECB’s monetary policy entering an upward interest rate cycle and the end of the third series of targeted longer-term refinancing operations (TLTROs) last June effectively end an eight-year period of cheap access to central bank funds by European banks, refers to Alpha Bank’s analysis.

The MPAs are among the ECB’s non-conventional monetary policy measures and provided long-term loans to banks at favorable terms, giving them an incentive to increase lending to businesses and consumers in the ZTE. As Europe faces a severe energy crisis and, consequently, the risk of stagflation, business activity could face a significant increase in its financing costs, a development that would have a negative impact on investment. With core inflation reaching record levels in June (8.6%), the ECB’s strategy to focus on curbing inflationary pressures and expectations was almost a one-way street, they add.

But how effective can it be in an environment of cost inflation? It is considered important that monetary policy makers follow a more gradual pace of interest rate increases, so that the expected reduction in money demand is anti-inflationary, without causing a severe and prolonged recession of the European economy. Concerns about corporate asset quality may emerge in the near term. Considering that many sectors were affected during the pandemic crisis and especially small businesses in the ZTE, the increase in financing rates will take place in a relatively burdensome environment. However, larger firms with easier access to international markets can more easily meet their liquidity needs and, moreover, are less vulnerable to tighter financing conditions. Also, accumulated cash reserves can help businesses absorb current price pressures, but only if growth does not slow significantly and energy prices do not rise much further, also estimated in the economic analysis.