ECB monetary transmission: One size currently fits all

The simple answer is yes. In fact, the transmission of monetary policy tightening started well before the hike cycle actually began. The long end of the curve started to increase materially when the ECB announced tapering in December, but also because of anticipation of rate hikes and higher inflation. Average borrowing rates for businesses and households increased significantly, mimicking the ECB’s policy rate hikes. When comparing to previous hike cycles, it’s hard to show exact timings as the anticipation of hikes already increases the long end of the curve, which is an important driver of business and household borrowing rates. So in charts 2 and 3, we measure the increase in rates for businesses and households starting from their trough. This is mostly just before the ECB started hiking.

Interestingly, and despite the fact that both interest rates for business and mortgage loans have increased proportionally, the impact on actual loan growth shows a large divergence. Mortgage loan growth has come down significantly, while business borrowing – although volatile – has seen strong months despite higher nominal rates. The ECB bank lending survey shows, however, that this is not because of investment opportunities, but mostly due to working capital and inventory reasons. With high input costs and businesses now stocking up – with inventories having been depleted amid shortages – this has required extra borrowing. Demand related to business investment has been falling for the past two quarters according to the survey. So non-financial corporate borrowing is currently elevated, but not because of investment plans. That suggests that the impact of higher rates is being felt across the board.

What we are currently witnessing is a usual pattern in a rate hike cycle: mortgages do adjust more quickly than business borrowing. The volume of lending to non-financial corporates generally only starts trending down at the end of the tightening cycle. That suggests that business borrowing is less interest rate sensitive than mortgage borrowing. However, in the past, hiking cycles also led to economic slowdowns or even recessions. At the current juncture, the recession is already triggered by the energy price crisis and the impact of the hiking cycle will be overlapping. As a result, once business demand for working capital is satisfied, the full impact of higher rates on business borrowing looks likely.

Turning to the transmission of the ECB’s tightening of monetary policy in the three largest economies up to now, we see that mortgage interest rates and business borrowing interest rates have increased the most in Germany since the beginning of the year and the least in France. At the same time, however, the spread between French and Italian government bond yields with Germany has widened this year (although spreads have fallen again since mid-October).

That wider spread in government bonds is also reflected in longer-term interest rates for businesses, but remains far from unwarranted tightening in these countries either. Loans with a maturity of more than five years have seen an increase in rates to just over 2.5% in Italy in October, while they stood at 1.7% and 1.9% in France and Germany, respectively. So for now, there is no evidence of extreme transmission of policy in countries with higher government bond yields.

The transmission of the ECB’s policy rate hikes so far will definitely be a hot topic at this week’s meeting. For both households and corporates, there has already been a clear tightening of financing conditions. A tightening that is already reflected in weaker mortgage growth but not yet in business borrowing. Interestingly, the tightening of financing conditions is not showing unwarranted tightening in peripheral markets, and government bond spreads have even fallen over the past two months. While tighter financing conditions should support calls for a slowing of the rate hike pace, there currently doesn’t seem to be a need to protect the transmission of monetary policy.