The European Central Bank has noted that eurozone banks tightened credit conditions in the third quarter and reported weakened loan demand, further supporting the ECB's cautious stance on additional rate hikes.
The ECB stated that heightened risk perception and reduced risk tolerance among lenders remain the primary reasons for banks tightening lending standards. Some banks have found that pressures stemming from geopolitical uncertainty and energy market volatility are intensifying.
Eurozone Credit Conditions Tighten
In its Bank Lending Survey published on Tuesday, the ECB noted: "The overall level of interest rates is the main factor dampening loan demand. Weaker fixed investment demand from small and medium-sized enterprises, as well as firms turning to alternative financing channels, have also weighed on loan demand to some extent."
The release of this survey comes as the ECB prepares to hold a two-day monetary policy meeting. Markets expect the central bank to keep rates unchanged. Although inflation remains close to twice the 2% target and the economy has shown resilience, the recent sharp rise in long-term bond yields, combined with factors such as the Middle East conflict, is adding further headwinds to the economic outlook.
Bank lending plays a critical role in driving economic activity, particularly corporate investment. At the same time, lending conditions serve as a leading indicator of how monetary policy affects economic growth. Since June, the ECB has raised borrowing costs twice, pushing the deposit rate to the upper end of the range considered neutral for the economy.
Rising Rates Lead to Lower Loan Demand in the Eurozone
A separate report published by the ECB on Monday found that firms believe credit costs are rising, and the decline in loan availability exceeds what their demand alone would explain. Additionally, Tuesday's report showed that over the past year, the ECB's balance sheet reduction has had a "slightly negative impact" on banks' market financing conditions and liquidity positions.
The report stated: "The impact on bank profitability is slightly positive on balance, as higher net interest income partially offsets small capital losses. Banks expect these effects to persist over the next 12 months."
David Powell, a senior eurozone economist, said: "The ECB's survey indicates that both credit supply and demand are weakening in the face of uncertainty stemming from the Middle East conflict and rising borrowing costs. At this week's meeting, dovish members of the ECB Governing Council will use these survey results to argue that the rate hike cycle should end soon."
However, the ECB noted that banks have observed gradually but steadily growing demand for loans to fund artificial intelligence (AI) infrastructure. The report said: "Most banks indicated that they have not yet introduced specific quantitative criteria in their credit standards for assessing AI-related loans. A small number of banks noted that AI applications and their associated risks are becoming increasingly important in the qualitative assessment of borrowers, with information technology firms subject to the most rigorous scrutiny."
It is worth noting that, in addition to the two reports from the ECB, weakening economic growth momentum also supports the central bank's cautious stance on further rate hikes. The latest surveys suggest that data to be released this Friday will show eurozone third-quarter economic growth may have slowed to 0.2% from 0.6% in the second quarter.
Meanwhile, several other surveys show that inflation across the eurozone's four largest economies did not show a clear broad-based upward trend in October. The European economy, which has shown considerable resilience since the outbreak of the Middle East conflict in late February, may be starting to lose momentum, with business activity also beginning to show signs of fatigue.
During the third quarter, European economic output was hit by multiple factors, including summer heatwaves, low water levels on major waterways, and surging global bond yields. Since then, the overall environment has deteriorated further, with France facing large-scale protests and growing questions about its public finances. The energy price surge triggered by the Middle East conflict is putting pressure on eurozone inflation.
However, policymakers have emphasized that they have not yet seen second-round effects such as wage increases. Some officials, including ECB Chief Economist Philip Lane, have said that a "measured" policy response should be sufficient to restore price stability.
ECB President Christine Lagarde previously stated that high eurozone inflation driven by elevated energy prices has not yet been transmitted to the broader economy. She said ECB officials are assessing "how much indirect impact is being transmitted through the economy and how we can best judge in advance if second-round effects begin to emerge."
Bank of France Governor Emmanuel Moulin has also taken a position on inflation similar to Lagarde's. He said the ECB expects "indirect and second-round effects to remain contained," with eurozone core price indicators only accelerating "modestly."
Slowing economic growth and the absence of further deterioration in inflationary pressures may have reduced the urgency for the ECB to act. For economists, this means the ECB may wait until December to raise the deposit facility rate for the third and final time, rather than hiking this week. This assessment stands in sharp contrast to market bets on several more hikes to come — traders expect the ECB to deliver three more rate increases over the next year.
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