Higher interest rates and much less credit application

As expected, the Fed and the ECB raised official interest rates by 0,25% this week. The Fed indicated that it is probably enough for the time being, while the ECB, through Christine Lagarde, reported remarkably explicitly that it is certainly not done with rate hikes yet. However, the rate hike was the smallest since the ECB started in July last year.

The problem for central bankers is that the full effect of interest rate hikes on inflation is first felt with a significant and uncertain lag. There is a considerable 'lag effect' of interest rate policy on inflation. The intermediate link is the business cycle. A rise in interest rates slows down the business cycle – with a lag – and a weaker economy reduces inflation – again with a lag. If the central bank continues to raise interest rates until inflation is really fully under control, it will cause more damage to the economy than necessary. Monetary policy thus remains largely an art rather than a science. A central bank must therefore be alert to all signals showing the influence of interest rate policy on the various components and processes in the economy.

Earlier this week, the ECB published the results of the so-called Bank Lending Survey, a quarterly survey among commercial banks that the ECB conducts. The latest shows that banks continue to tighten their credit conditions. But the most remarkable thing was that the demand for credit from companies and households is currently declining very sharply. This is visible in the first graph. The more negative this series, the more banks report lower credit demand. While this is not exactly an exact science – it is not a record of actual lending volumes – the chart suggests that corporate credit demand is currently falling faster than during the Euro crisis and almost as fast as during the 2008/09 credit crisis. This probably indicates that the previously implemented interest rate hikes are already making themselves felt. When asked why the demand for credit is decreasing, banks report that this is mainly due to higher interest rates and companies' reduced willingness to invest. The conclusion that needs to be drawn is that earlier interest rate hikes are already starting to have a significant impact on the economy.

The results of the Bank Lending Survey undoubtedly played an important role within the ECB in the decision to raise interest rates by only 25 basis points. I can understand that. On the other hand, inflation remains much too high.

In the distant past, central bankers sometimes paid attention to the development of money growth. They may still do, but they don't talk about it anymore. I do. The Bundesbank used to look mainly at the broad aggregate M3 and the ECB initially did the same. The image below zooms in on M1. This measure only includes components that allow people to make immediate purchases. In March this money supply was 3,9% smaller than one year previously. Such a decline has never been seen in the existence of the euro. The shaded areas in the chart indicate periods when eurozone GDP contracted. The recessions of 2008/9 and 2011/13 were both preceded by a sharp drop in money growth. Draw the conclusion yourself.

Incidentally, Fed Chairman Powell believes it is possible to achieve the inflation target of 2% without a recession. Somewhat touchingly was his comment during the press conference that he realizes that such an outcome would be at odds with past experiences. It sounded like 'hope against hope'. Powell is of course not that naive. The following chart shows what his hopes are based on. Just like with us, there are more vacancies in the US than unemployed. It is a sign that the labor market is very tense. What you hope is that that tension can disappear a bit, so that wage pressures decrease without a sharp rise in unemployment, say without a recession.

The graph shows that the number of vacancies per 100 unemployed persons has fallen from approximately 200 to approximately 165, while unemployment has not increased. So here you see an apparent relaxation of the labor market that is not accompanied by rising unemployment. Still, I think Powell's hopes will be in vain. My favorite measure of wage growth in the US is the Atlanta Fed wage growth tracker. After June 2022, wage growth has decreased according to this measure, but in February and March it accelerated again. The next picture shows that. It also shows that, if possible, we have an even bigger inflation problem in the Netherlands.

Confidence in industrial entrepreneurs continues to fall
The confidence of Dutch industrial entrepreneurs is declining. However, the two benchmarks we have for this give a different picture. The CBS benchmark fell from +4 in March to +3 in April. That is slightly above the long-term average of +1. The benchmark of the NEVI fell from 46,4 in March to 44,9. That is emphatically below the neutral level of 50. The NEVI benchmark is based on a much more extensive series of survey questions than those of Statistics Netherlands. According to the NEVI survey, entrepreneurs are mainly negative about the order inflow. At the moment they still have enough work because bottlenecks that date back to the time of the pandemic delayed production for a long time. Those have now been resolved. The picture that emerges from the survey is not very positive. Hopes are pinned on the international environment.

A changing picture
The international environment shows a mixed picture at best. At our eastern neighbors and most important trading partner, the value of exports is visibly weakening. Now this undoubtedly has to do with energy prices, but the following picture does not inspire much optimism.

On the other hand, things seem to be going much better with the car industry, which is so important to Germany. The next picture shows that production (measured on the basis of the number of cars produced over a 30-month period) has been on the rise for a year now. A level has now been reached that is more than XNUMX% higher than a year ago. Judging by the following graph, you would say that there is still plenty of room for further improvement.

The recovery in economic growth in China is expected to give a swing to international trade and global activity this year. Data published in April showed that China's exports, imports and retail sales grew above expectations in March, but industrial production disappointed. As the next picture shows, business confidence fell in April. Confidence in the services sector remains high, but the confidence index for the industry fell below 50 again in April. This indicates that the recovery in Chinese activity is far from smooth. I assume this will work out because policymakers are committed to economic recovery.

This week, the Fed and the ECB raised key rates again. The Fed now seems to be on hold, the ECB will continue for a while, but the end of the process of interest rate rises seems to be in sight.

I hold my heart a little bit. The ECB Bank Lending Survey suggests that there is currently a marked decline in corporate (and household) demand for bank credit. The M1 money supply has been shrinking for some time. These are traditional signs of impending economic downturn. In plain language: a recession is coming.

In the US, the central bank boss has pinned his hopes on an unprecedented development, namely that the labor market will relax, thereby moderating wage growth and inflation falling to 2% without pushing the economy into recession. have to get. Even the economists of the Fed, so say the boss's staff, think such a scenario wishful thinking is.

Meanwhile, Dutch industry is weakening, the recovery of the Chinese economy is not yet going smoothly and world trade still appears to be depressed, although German car production is finally picking up again.

Hans de Jong

Han de Jong is a former chief economist at ABN Amro and now a resident economist at BNR Nieuwsradio, among others. His comments can also be found on Crystalcleareconomics.nl

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