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European Central Bank Likely to Hike Rates Amidst Slowing Economy
Cautious Optimism for Rate Hike
The European Central Bank (ECB) is expected to hike rates once again this week, bringing its deposit rate to 3.75%. Despite inflation remaining high, market analysts believe that the ECB is nearing a peak. Economic indicators point to a slowdown in the real economy and a slump in loan demand to a record low. However, the real question lies in what will happen in September.
Wisdom in Leaving September Policy Meeting Open
Deutsche Bank's chief economist, Mark Wall, predicts that the ECB will follow through with the rate hike this week. Wall highlighted the weaker than expected PMI data and bank lending survey as factors that support the ECB's wisdom in keeping the outcome of the September policy meeting open. The ECB has already raised rates by 400 basis points since July last year, marking the fastest tightening cycle on record for the central bank. This tightening cycle was prompted by supply chain disruptions and an energy crisis caused by the war in Ukraine.
Effects on Loan Growth and Economic Activity
The sharp rise in rates can have severe effects on loan growth in the euro area, which in turn impacts economic activity. According to the ECB's quarterly survey, firms' net demand for loans dropped significantly in the second quarter of 2023, reaching an all-time low since the survey began in 2003.
Challenges for Euro Zone Banking System
Banks play a dominant role in financing the euro zone economy, as capital markets are not as liquid and deep as those in the United States. The ECB's tighter monetary policy is already taking effect, particularly through banking credit, according to ECB Chief Economist Philip Lane. Recent data has shown a larger than expected shrinkage in euro zone business activity in July. Factory output experienced the fastest decline since the start of the Covid-19 pandemic, and demand in the services industry of the bloc also decreased as consumers struggled with high inflation.
Inflation Variances Across Euro Zone Countries
While headline inflation fell more than expected to 5.5% in June, core consumer prices, excluding food and energy, rose 5.5% year-on-year. There are significant differences in inflation rates among euro zone countries. Some countries have already fallen below the 2 percent target, while others, like the Baltic region, have inflation rates that are only slightly below 10 percent.
The ECB's Fine Line
The ECB faces the challenge of reassuring markets that it will maintain elevated rates for an extended period, even as the economy cools down. Despite the slowdown, the tone is expected to remain hawkish, as inflation levels are still high and the ECB cannot be certain that rates have peaked yet.
Conclusion: Implications for New Businesses Amidst ECB Rate Hike
The European Central Bank's decision to hike rates amidst a slowing economy has significant implications for new businesses in the euro zone. While the ECB aims to combat high inflation levels, the tightening monetary policy poses challenges and uncertainties for entrepreneurs and startups.
One of the immediate effects of the rate hike is the impact on loan growth and economic activity. As the rates rise, there is a sharp decrease in firms' net demand for loans, reaching a record low. This can make it harder for new businesses to acquire necessary funding and potentially hinder their growth prospects in the market.
Furthermore, the challenges faced by the euro zone banking system also have a ripple effect on new businesses. Banks play a crucial role in financing the economy, and the ECB's tighter monetary policy is already causing a shrinkage in business activity. This, coupled with declining factory output and decreased demand in the services industry, presents a challenging environment for startups to navigate.
Furthermore, the inflation variances across euro zone countries create additional uncertainty. Some countries are experiencing inflation rates well below the target, while others face rates near 10 percent. Such divergences can complicate pricing strategies and market dynamics for new businesses operating across borders within the euro zone.
As the ECB walks a fine line between maintaining elevated rates and supporting economic growth, new businesses should carefully monitor the evolving situation. Adapting to higher interest rates and seeking alternative funding sources, such as venture capital or angel investors, may become necessary. Attention to market conditions, consumer behavior, and cost management will be crucial for startups to survive and thrive amidst the evolving economic landscape in the euro zone.
Article First Published at: https://www.cnbc.com/2023/07/27/european-central-bank-set-to-hike-rates-as-it-edges-closes-to-a-pivot-point.html