The ECB’s Bank Lending Survey (BLS) was released this week. This is always an interesting read as it is the banking sector themselves who speak about trends in the supply and demand for credit in various sectors of the economy. While the main headlines were about corporate loan demand being the weakest in a number of years; we believe there are other features that are just as important about which we have seen little commentary, if at all.
Let’s talk about the bad news first. Demand for corporate loans was in fact weak, and this is not good news for growth. This is a reflection of higher cost of credit in a subdued growth environment, which is not a mix conducive to increasing Capex dramatically. CFO’s are paid to wait before investing huge sums of money given loans are very expensive and growth is low, in other words. The banks also said they expected demand to fall further in Q3, albeit at a slower pace. Households also demanded less credit than in Q1; however, the bottom was reached a couple of quarters ago for mortgages and consumer credit, and currently the net % of banks reporting less demand in these segments is declining.
Now onto some better news, supply of credit does not look particularly tight compared to the survey’s history. On the net 14% of banks responded they had tightened conditions for obtaining corporate loans compared to Q1, down quite steeply from 27%. While this level is still somewhat elevated compared to previous years, it is fair to say that this does not sound like a complete disaster. Regarding mortgages, the BLS delivered the third quarter in a row of a decline in banks reporting tighter standards. The peak at just under a third of banks in tightening mode came in Q4 2022, just before what could have been a much worse winter than what eventually happened. Today the number is 8.4%, again hardly evidence of severe tightening. Lastly, consumer credit remains the sector (along with CRE) where banks remain more hesitant when asked to extend credit. This is business as usual and would actually be worrisome if it weren’t the case from a bondholder and from a financial stability point of view. These are the more cyclical sectors which tend to exhibit higher NPLs and so it makes perfect sense that standards are being raised. Going forward banks forecasted tighter lending standards still in Q3, but at a reduced pace vs Q2 for corporates, at the same pace for mortgages and at a faster pace for consumer loans.
In conclusion, the second half of the year is likely to deliver growth well below trend in the Eurozone, albeit with quite a bit of dispersion amongst countries (for example growth in Germany is likely to be negative with Spain expected to be the complete opposite). Although this is very far from a rosy environment, it is also true that it is nowhere near a hard landing. Without a doubt things can change very quickly and we cannot ignore that the global economy has no bullets left to fight a large external shock. But with a hard landing increasingly being priced out, monetary policy rates seemingly near the peak and yields at very attractive levels we do think fixed income markets are well placed to deliver attractive risk adjusted returns.