Falling loan demand builds rate cut pressure as ECB prepares to meet

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Eurozone banks reported a “substantial” drop in loan demand from companies, prompting calls for the European Central Bank to signal it will cut interest rates soon when it meets this week.

The ECB said on Tuesday its quarterly survey of lenders showed “demand for loans from firms declined substantially, contrary to banks’ expectations of a recovery”. Economists said the fall in borrowing, which reflected lower investment plans, meant the region’s economy was likely to continue stagnating.

However, there were also signs of banks starting to stabilise the availability of credit to the economy in the first three months of this year, following a four-year tightening period, as they cut the cost of mortgages for the first time in more than two years.

The survey results will feed into the discussion among ECB rate-setters when they meet this week about the extent to which tight financing conditions are squeezing activity and cooling inflationary pressures. 

While investors are convinced the ECB will start cutting its benchmark deposit rate from its record high level of 4 per cent in June, there is more doubt over the pace and total amount of policy loosening that will follow — especially if the US Federal Reserve does not follow suit. 

Some analysts think falling loan demand from companies will increase the chances of rate cuts in June and at most of the four other remaining ECB meetings this year.

“This is a clear indicator that monetary policy remains too tight in the euro area,” said Tomasz Wieladek, an economist at investor T Rowe Price. 

“The ECB will take this into account when deciding to ease policy in June,” he said. “I believe that the survey data today and the implications for investment make four to five sequential rate cuts in 2024 much more likely.”

Felix Schmidt, an economist at German bank Berenberg, said the survey results meant “monetary policy remains restrictive and, together with the fragile economic situation and falling inflation, this increases the pressure on the ECB to start cutting rates in June”.

Banks forecast there would be a further “moderate net tightening” of credit availability but an increase in loan demand in the second quarter. They predicted corporate loan demand would keep falling but said mortgage demand was set to rebound in a positive signal for house prices in the eurozone, which fell last year for the first time in over a decade.

Some economists pointed to the fact that banks reported the least amount of extra tightening of credit standards for over two years along with the fall in mortgage lending rates to argue that the tightening of financing conditions may have peaked.

Martin Wolburg, an economist at Generali Investments, said the latest data, including separate figures showing a slight rebound in lending to companies at the start of this year, signalled that “the hiking-induced tightening has largely run its course”.

He forecast the ECB would cut rates by a quarter percentage point at least three times this year. But he added it could cut borrowing costs “even more as the further postponement of the first Fed rate cut might offset some easing of financing conditions in the euro area”.