ECB faces trickier rate path after bank lending survey shows tighter conditions

The European Central Bank’s latest bank lending survey paints a less optimistic picture for the euro zone economy. Banks are further tightening their lending criteria, while demand for loans is dropping across the board, largely because higher interest rates continue to weigh on borrowing activity.

Key findings from the October survey, covering developments in the third quarter, include:

• Corporate lending: A net 9% of banks reported stricter credit standards, above the 5% that had been anticipated
• Consumer credit: A net 14% of banks noted tighter lending standards, while conditions for housing loans remained unchanged
• Corporate loan demand: Fell by a net 6%, reversing a 3% increase in the second quarter
• Housing loan demand: Dropped by a net 27%, compared with a 15% decline in the prior quarter

Banks also expect further tightening in lending standards and weaker household loan demand in the fourth quarter, which bodes poorly for the outlook.

The data reinforce that higher interest rates are already slowing the economy. Weaker borrowing and tighter credit conditions should eventually weigh on investment, consumption and broader economic activity.

With banks also having to contend with geopolitical uncertainty and worsening risk perceptions, there is little reason to expect credit conditions to improve in the near term.

That leaves the ECB with a difficult balancing act.

Traders are pricing in roughly 90% odds of no rate change in November, making the immediate decision straightforward. But December is another question, with markets assigning around 70% odds of a 25-basis-point rate increase.

Today’s lending survey gives the central bank another reason to proceed cautiously before committing to further tightening. The inflation outlook remains a bigger consideration, especially with energy prices still posing upside risks. However, if incoming data continue to soften, markets may have to reassess how much additional tightening the ECB can realistically deliver.

For now, December still looks like a plausible option for another rate hike. However, the case for tightening further beyond that may be less clear amid ongoing fiscal worries and a slowdown in economic momentum.