ECB is overtaking

The European Central Bank (ECB) will raise rates more aggressively this year than the US Federal Reserve, which is already completing its monetary tightening cycle, analysts at the Economist Intelligence Unit said. According to their forecast, in 2023 the European regulator may raise rates by another 150 basis points. This will increase the risks of “financial fragmentation” in the euro area – in particular, borrowers in Italy and Spain will face more pronounced negative effects of rising borrowing costs than in France and Germany.

The peak of Fed and ECB rate hikes may be passed by the middle of this year, analysts at the Economist Intelligence Unit (EIU, an analytical division of the Economist group) expect. They recall that by the beginning of 2023, the Fed raised the key rate by 425 basis points (bp), the ECB – by 250 bp. According to the EIU forecast, rates may remain at high levels for another year, despite the rapid slowdown in inflation (in the US, its peak of 9.2% was passed in June last year, in the euro area – in October, 10.7% ). European inflation overtook US inflation in mid-2022, but excluding energy and food prices in the US remain higher. A second wave of regulatory tightening (for example, in the event of a sharp rise in commodity prices) will lead to a global recession, the authors of the report warn. According to the forecast, the US may face a “mild technical recession” in the first half of 2023, while the euro area may face output stagnation.

We note that the Fed has already slowed down the pace of rate hikes – after a series of four increases by 75 bp. (in December, the rate was increased by less, by 50 bp). According to the results of the Fed meeting this week, growth of only 0.25 percentage points is expected. According to the EIU forecast, between this meeting and the May meeting, the rate could rise by 75 bp. The European Central Bank started raising rates in July. In September and October, the increase was 75 points, in December – 50. This year, the ECB is expected to be more aggressive than the Fed – EIU analysts predict two increases of 50 bp. in February and March, and two more – by 0.25 bp. – in May and June, which will bring rates in the eurozone to the level of 3.5-4%.

The lag between the actions of the Fed and the ECB has a significant impact on exchange rates. Last year, the tightening of the policy of the American regulator and the desire of investors to avoid risks led to a record strengthening of the dollar, in November-December it began to weaken (at that time the ECB raised rates). The narrowing of the gap between the rates of the two central banks may continue to put pressure on the dollar, but its noticeable weakening against major currencies may occur only after the alignment of rates and a fall in demand for risk-free assets, the EIU believes.

Also, the increase in ECB rates carries additional risks for borrowers. It may lead to an increase in spreads on government bonds, investors may initiate sales of securities of countries with a less stable fiscal policy (previously, the regulator, as part of quantitative easing, bought out a significant part of new obligations, in addition, it has a mechanism for buying assets in case of strong volatility in financial markets).

Another manifestation of “financial fragmentation” may be the uneven rise in the cost of loans to the private sector. In Italy and Spain, the average loan term is shorter than in Germany and France, and the share of debts with fixed rates is 47% and 62% versus 80% and 83%, respectively. Another risk group is companies that are faced with a sharp increase in energy costs and are forced to attract loans to cover operating expenses. Households, in turn, will face an increase in mortgage rates – the most exposed to the negative consequences of such an increase, again, the markets of Spain and Italy (due to floating rates), the EIU believes.

Tatyana Edovina