The credit impulse for households and non-financial companies in the euro area increased to -4.5% of GDP in November, from -5.2% in October, bringing the three-month average from -5.0% to -4.9%. The latest three-month average compares with a low of -3.1% during the euro crisis and a low of -8.3% during the global financial crisis.
The credit impulse, which measures the change in credit growth rather than the real rate of expansion, is the best indicator of the stimulus to the economy from lending activities. More specifically, loans to households and non-financial corporations are more highly correlated with the growth of private demand (household consumption plus gross fixed capital formation).
Despite the stabilization, the three-month average of credit to households and non-financial companies fell by 8.0 percentage points from its recent peak of 3.1% in October 2022. This is consistent with an impact of around 7.1 percentage points on private sector demand due to the decrease in credit supply.
Standard economic models, such as those used by the ECB, estimated - at the start of the interest rate hike cycle - that the impact of higher rates should have already exceeded 2% of gross domestic product by the end of 2023 and could reach 4% by the end of 2024. Nevertheless, the impact seems to have been substantially smaller thus far.
Why the surprise and what does it mean for 2024? It could be that the economy has been pushed further into the upward cycle than expected, that monetary policy has lost its efficiency or that it is less restrictive than thought.
There is still the danger that the models are right about the magnitude of the impact, but wrong about the timing. Perhaps the European economy will suffer the impact of 4% on GDP, but later and with a faster deceleration than expected.
The baseline scenario seems to be that the eurozone will avoid a deep slowdown because the labor market has remained exceptionally resilient so far. A deterioration in employment prospects could be a catalyst for pushing a weak economy into recession. As workers lose their jobs or fear losing them, they reduce their spending, further depressing economic activity and labor demand.
To assess this risk, labor market stress (fear of unemployment) can be analyzed using a temporal measure, similar to the Sahm rule, which is used as an indicator of recession in the US. This shows that labor market conditions in the eurozone are a long way from those that have historically been consistent with the start of the recession. This could change, and the situation needs to be monitored, but there are few signs that the edge of the cliff is near.
The Governing Council has focused directly on underlying inflation measures to assess the effectiveness of its monetary policy. The indicators that provide the clearest reading remain high, but have been on a downward trend for most of 2023. With product price inflation, in particular, declining, the big question is what will happen to services (of which wages make up a large part of the costs).
Normally, past inflation is one of the main drivers of wage increases, as workers try to regain purchasing power. This suggests that as high global inflation falls, wage growth will slow. This judgment supports our forecast, which shows services inflation falling to 3% by the end of 2024, from around 4.5% at the end of 2023.
If the inflation outlook evolves as expected, this will probably allow the ECB to make a cut in June and deliver 75 basis points of easing by the end of the year. Until then, policymakers will talk a lot about monitoring inflation, as they don't want expectations of rate cuts to take hold too soon. If inflation falls faster than expected, this could open the door to an early cut.
With economic activity more resilient than expected, and a scenario of the ECB starting later the easing cycle compared to the Fed, the first half of 2024 seems to hold the prospect of the euro continuing to strengthen.
