Rate Hike Cycle Will Come To An End If Lending Slows Down

It would appear that the yearlong cycle of interest rate hikes is coming to an end since the central banks are getting ready to declare it a thing of the past. They are taking the wheel and applying the brakes.

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At the Federal Reserve's March 22 FOMC press conference, Chairman Jerome Powell laid the foundations for the future. The speaker replied that, as we go forward, we will continue to pay attention to the possibility of tightening credit conditions, because we believe the risk is real. As we consider the possibility of further rate hikes for us, we will certainly be on the lookout for them as well. This is code for a clear indication that policymakers believe tighter financial conditions will replace the blunt tools they've been employing over the last few years.

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Increasing interest rates are putting potential corporate and private borrowers off as soon as day comes to an end, and they are reimbursing their debts if possible as soon as they can. A worrisome scare over bank deposit security and a reluctance to take on debt constitute the makings of a credit crunch, despite the fact that the global banking system remains awash in liquidity -- and central banks have already fallen over themselves to keep the taps open fully.

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Next week, the Bank of England releases its credit conditions survey and a month after that, the Bank of England releases its quarterly monetary policy review. According to the end-2022 summary, British lenders appear to be the most frightened since the global financial crisis started. There are a number of reasons why the European Central Bank's quarterly bank-lending survey is due to arrive by the end of April, well in advance of May 4's gathering. The January report indicated that some southern countries have experienced negative Euro loan growth. A comprehensive overview of the likely conclusions of the next Fed Senior Loan Officer Survey will be available to policymakers less than a week after the FOMC meeting, almost a week after the next FOMC meeting.

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Following the failure of three US banks, my colleague Paul Davies wrote in a piece that I contributed last month, that at a certain point, bank stability becomes a function of monetary policy, as tightening accelerates like a slingshot through the banking system. "The collapse of Credit Suisse Group AG into UBS Group AG's arms has highlighted that problems with bank balance sheets are not confined to the United States alone." This statement clearly highlights the fact that problems with bank balance sheets are not confined to the United States. The last time credit flow dropped this sharply, according to Daniel Kral, senior economist at Oxford Economics, was during the euro crisis a decade ago when credit flows plummeted.

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In its macroprudential bulletin of the ECB, the ECB has sounded a warning about real estate risks just in time. During the past decade, the net asset value of commercial property investment funds has tripled to over €1 trillion, which indicates that there is something the government should have been more aware of. According to Trade Algo, most of the investment-grade real-estate corporate debt that is available for purchase is trading at extremely high yields. In the property sector, property securities have an average coupon of less than 1.6% on euro-denominated debt, according to Trade Algo. In current market conditions, however, the cost of replacing equivalent debt is closer to 5%. This leads to the rub, as property is one of the most interest-rate sensitive industries.

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As the financial sector slowly recovers following the tough loan market of the past few months, the overall borrowing in the euro area fell to 4.3% in February compared with 4.7% the month before. Growth in corporate lending has nearly halved in the past quarter which was nearly 8%. The Italian lending growth is near breaking negative.

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A similar crisis is being faced in the UK as well. According to Deutsche Bank AG analysts, total lending as a percentage of the economy dropped in February to 0.5%, the lowest reading since 2013. It is not just household mortgage lending that is being impacted by higher interest rates. Overall borrowing has slowed down for the second consecutive month as a result of the higher rate. Corporate debt repayments have continued to be strong for a second consecutive month. A recent rise in credit spreads was estimated to be equivalent to a slight increase in rates by about 25 basis points, and therefore Bloomberg Economics expects the Bank of England to hold off on raising interest rates at its next meeting in May.  

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It would be a grave mistake by policymakers to continue raising interest rates despite these banking headwinds, particularly as year-end headline inflation forecasts indicate that there will be a significant slowdown in headline inflation in the coming year. Certainly, it isn't surprising that core prices, excluding food and energy, remain above their 2% target. Our economic infrastructure collapsed a long time ago, so it must take longer for it to come down. Yet surely our monetary overlords have the wit to see through this issue before the collapse of the economic infrastructure. Pausing seems to be the least expensive option when it comes to the price.