Latest / The European Economy Podcast with Fexingo: ECB, Eurozone, and Continental Markets / Why Eurozone Banks Are Raising Loan Rates Despite ECB Cuts
Transcript
- Lucas: So here's a puzzle that's been bothering me for a few weeks now. The ECB has cut its key deposit rate twice since June of last year — it's now at 2.25 percent — and yet if you're a small business in Germany or France trying to get a new loan, you're actually paying more today than you were a year ago. Luna: Right, I've seen that in the data. The average rate on new business loans in the Eurozone ticked up to 4.8 percent in May, from 4.6 percent in January. That's not what you'd expect after rate cuts. Lucas: Exactly. And look, if this episode made something click for you about why rate cuts aren't getting through, walking through the economy with us, maybe it's worth a coffee. That's buy me a coffee dot com slash fexingo. No pressure — just if it was useful. Luna: Absolutely. It's what keeps this show ad-free and independent. Anyway, back to the puzzle — why are banks raising rates when the ECB is cutting? Lucas: One big reason is that banks' own funding costs haven't come down as fast as the ECB's rate. A lot of Eurozone banks are still paying more on deposits — especially time deposits — because they're competing for funds. The average deposit rate for households in the Eurozone is still around 2.1 percent, down only about 30 basis points from the peak. Luna: So the banks are squeezed. Their cost of funds stays high, so they pass that on to borrowers, even though the ECB is trying to ease. Lucas: Exactly. And there's another layer: commercial real estate. A lot of Eurozone banks have significant exposure to office and retail property that's lost value. The European Banking Authority flagged last month that non-performing loan ratios for CRE are creeping up — they're around 4.5 percent now, compared to 3.2 percent a year ago. Luna: So banks are getting more cautious. They're pricing in higher risk premiums on new loans, especially for business borrowers who might be in sectors tied to real estate. Lucas: Yes. And it's not uniform across the bloc. Look at Germany — the EWG ETF, which tracks German equities, is up over 4 percent in the last five days, partly because the market is betting that rate cuts will eventually help. But on the ground, German banks are among the most aggressive in raising loan rates. The Bundesbank's April lending survey showed that the share of banks tightening credit standards for businesses rose again. Luna: That's the opposite of what the ECB wants. They're trying to stimulate investment, but if banks are tightening, the transmission mechanism is broken. Lucas: And it's not just Germany. In France, the story is similar. French banks have increased their average lending rate on new business loans to 4.9 percent, according to Banque de France data. That's up from 4.5 percent in December. And the French economy, which is more services-oriented, is feeling it. Luna: I wonder about the role of the US jobs report we saw this week. Only 57,000 new jobs in June — that's weak. And the labor force participation rate fell to its lowest in 50 years outside the pandemic. That signals a slowing economy globally, which might make Eurozone banks even more cautious. Lucas: Absolutely. The US slowdown matters because it weakens export demand for Eurozone goods. And if banks see weaker demand ahead, they're going to be even more hesitant to lend. The VGK, the broad Eurozone ETF, is up 2.5 percent in five days, but that's partly a relief rally on the assumption that the Fed will cut rates too. The underlying economy is still fragile. Luna: So what can the ECB do? They've already cut twice. The market is pricing in another cut in September. But if banks aren't passing it through, more cuts might not help much. Lucas: Christine Lagarde hinted at something interesting in her press conference last week. She said the ECB is looking at 'other instruments' to ensure monetary policy transmission. That's code for targeted longer-term refinancing operations — TLTROs — or possibly even tiering of reserve requirements to ease the burden on banks. Luna: TLTROs worked during the pandemic. They gave banks cheap funding as long as they lent to businesses. But that was a crisis tool. Using it now feels like admitting the rate cuts aren't working. Lucas: Right. And there's a political dimension too. Lagarde is also mulling her own future — there were headlines Friday about her considering an early exit if French politics get complicated. That uncertainty doesn't help. Banks like predictability. Luna: She's been a steady hand through a lot. But an early exit would create a leadership vacuum at the ECB just when they need to be creative. Lucas: Exactly. So the bottom line is this: the ECB's rate cuts are being absorbed by banks' own balance sheet issues — higher deposit costs, CRE losses, and general caution. Until that changes, the pass-through to the real economy will stay weak. Luna: And businesses, especially SMEs in Germany and France, will keep paying more for credit. That's a headwind for the recovery. Lucas: One thing to watch is the next ECB lending survey, due in late July. If credit standards ease even a little, we could see a shift. But if they keep tightening, we're in for a longer period of sluggish investment. Luna: I'll be watching the Italian and Spanish data too. The EWI and EWP ETFs are up more than the core markets lately, suggesting investors are pricing in a more positive outlook for Southern Europe. But if the lending channel stays broken there too, those gains could reverse. Lucas: Good point. For now, the divergence within the Eurozone continues. Core banks are raising rates; Southern banks are more competitive. That's a story we'll keep tracking.