The eurozone has stabilised after the turmoil sparked by the Greek debt crisis but how to get credit flowing freely to business again remains a conundrum for the European Central Bank, analysts say.
At a regular monthly meeting today, analysts expect the ECB to keep interest rates at a record low one per cent for a 16th consecutive month – at that level, borrowing should be simple but in practice it is not.
Banks, fearful that the economic recovery is already slowing and will face more headwinds as governments cut spending, are becoming more reluctant to lend as the risk of not getting paid back increases in more difficult times.
The main ECB interest rate will remain at a record low of one per cent for the 16th month running and could stay there “deep into 2011,” IHS Global Insight’s chief European economist Howard Archer said.
“The ECB is very aware that still limited recovery in the eurozone will be buffeted over the coming months by tighter fiscal policy increasingly kicking in across the region and likely slower global growth,” Mr Archer added. Eurozone governments have begun to curb spending to trim public deficits and debt, a development some economists say will hamper economic recovery.
Accompanying tighter government policies is more restrictive bank lending, as revealed by the latest ECB survey of 120 banks across the 16-nation bloc.
“The recent tightening in bank lending standards for companies suggests that the sovereign debt crisis has had some negative impact on overall lending conditions in the euro area,” Citi analyst Juergen Michels noted.
Credit is crucial to economic expansion but although eurozone banks have passed stress tests showing that they are generally in sound financial health, they are still reluctant to lend.
ECB data last week showed that loans to non-financial companies fell 0.4 percent in June although lending for home mortgages has picked up.
Weak demand has been pointed to in the past as a reason why less credit was flowing from banks to businesses but companies have been dusting off expansion plans and will need to borrow to see them through to fruition.
Consultancy group Ernst & Young said it expects “that tight lending criteria will remain for some time, which will hamper growth in the eurozone in the next couple of years.”
The ECB still lends commercial banks as much cash as they ask for at one per cent but has seen demand ease significantly.
On Tuesday, 125 banks sought a total of €154.8 billion in one-week loans, down from recent averages close to 150 lenders and €200 billion.
Controversial ECB purchases of government debt from banks, another way of helping credit markets, have declined to just €81 million in the past week from €26.5 billion in the programme’s first weeks in May.
It is another sign that crisis conditions in sovereign debt markets have eased but also shows that the banks are not using a facility intended to give them easy access to funds for later lending to their clients.
Meanwhile, the European Commission’s Economic Sentiment Indicator has hit its highest level in more than two years, led by eurozone locomotive Germany, strong order books and a rise in consumer confidence.
In Britain, the Bank of England is expected to keep its benchmark interest rate at a record low 0.50 per cent because a recent upturn in economic growth there is seen as temporary, analysts said.