The weakening of the global inflationary wave is causing major central banks to start cutting interest rates. The ECB has lowered interest rates by 25 basis points to 3.5% due to the decline in headline inflation in the Eurozone and the outweighing growth risks. ECB President Christine Lagarde said that they made the decision for the second interest rate cut this year unanimously. Lagarde, who mentioned the ECB's 2% inflation target, said that the latest data provided confidence that they were moving towards the target. Headline inflation in the Eurozone fell from 2.6% in July to 2.2% in August, the lowest level in the last three years.
The decline in industrial production in Germany and Italy has also raised concerns that the Eurozone economy is slowing down after a brief period of growth earlier this year. The ECB's text stated that cost pressures on labor have eased and prices have stabilized as high wages reduce corporate profit margins. The text also emphasized the restrictiveness of financing conditions and the weakness of economic activity. Lagarde said that further interest rate cuts are expected in the coming period, but that the probability of this at the next meeting in October is low. The ECB lowered its growth forecast for the Eurozone this year from 0.9% to 0.8% and its forecast for 2025 from 1.4% to 1.3%. It maintained its inflation forecast at 2.5% for this year and 2.2% for next year.
The ECB's decision to cut interest rates is due to weak growth. While high interest rates continue to hit the housing sector in Europe, credit growth points to stagnation. According to EYnews' analysis of data from national banks in Germany, France, Spain and Italy, growth in mortgage loans is not expected for the first time in 10 years. This rate was recorded as 4.9% in 2022. The lowest growth rate previously recorded was 0.2% in 2014. Mortgage loans account for almost half of total loans in the Eurozone, and we see that credit demand has decreased in the high interest rate environment. EYnews expects mortgage lending to recover to 3.1 percent growth from 2025. It expects growth of 4.2 percent in 2026 as borrowing costs fall and inflation slows. Commercial and consumer lending are following a similar pattern. Commercial lending shrank by 0.1 percent last year and is expected to grow by just 0.5 percent this year. Consumer lending is expected to grow by 0.9 percent this year.
According to EY’s forecast, banks are taking significant losses on NPLs, but their capital buffers appear strong. NPLs are expected to rise from 2 percent of total loans this year to 2.3 percent in 2025 and 2026, but this will be well below the peak of 8.4 percent during the eurozone debt crisis in 2013. “The housing market has been hit hardest this year by stagnant growth, but as the cost of living and borrowing falls, home purchases will pick up again, with demand for credit from both consumers and businesses,” Omar Ali, EY’s global financial services leader, told the FT.
The Fed is at a crossroads again as it prepares for a four-year cut cycle. The question on everyone’s mind is whether the first cut will be 25 basis points or 50 basis points. Officials are also discussing how quickly to ease monetary policy. As markets calm, swap markets have become more prominent in pricing 25 basis point cuts. Some economists are open to further cuts as inflation grows and borrowing costs are set to avoid causing economic damage by keeping them too high. A half-point cut in September could allow the Fed to more quickly bring borrowing costs back to normal, lift restrictions on the economy and prevent the labor market from weakening. Fed Board member Christopher Waller says he is “open-minded” about the size and pace of rate cuts and would support a larger cut if needed. But Waller says any move should be made “carefully.”
New York Fed President John Williams is undecided about the size of this month’s cut, but says the central bank is “well-positioned” to meet its inflation and employment goals. “We’ll get together and naturally analyze and discuss everything,” Williams said of the size of the first cut. “There’s an argument to be made for 50 basis points, but it’s complicated to communicate, and there’s no compelling reason to take on that challenge,” said Loretta Mester, who is retiring from her post as Fed president in Cleveland. Former Fed vice chair Richard Clarida said that half-point cuts “may trigger a 50 basis point cut that, ‘Wow. What do they know that we don’t?’”
Producer prices in China continue to fall due to deflationary concerns. Industrial producer prices fell by 1.8 percent annually in August, the biggest decline in the last 4 months, due to the impact of steel, agriculture and other sectors. Expectations were for a 1.4 percent decrease. The consumer price index in China increased by 0.6 percent annually.
The latest data reveals a weakening economic activity in the Chinese economy. Many experts who closely follow the Chinese economy are concerned about the deflationary trends that have emerged in the country. Former Central Bank of China Governor Yi Gang also emphasized in a statement he made last week that China needs "proactive fiscal policy" and "harmonious" monetary policy measures to support economic demand. Yi Gang stated that China's GDP deflator has been negative for the last few quarters, and that this situation strengthens deflationary elements in the economy.
Economists believe that if deflation becomes permanent, companies will reduce their investments and have to cut costs, which will have negative effects on wages and employment. This could negatively impact workers’ incomes and therefore consumption.
Oil prices fell below $70 for the first time since December 2021. The decline is driven by concerns that weak economic growth will negatively impact demand. Chinese import data and OPEC’s expectations for a decline in oil demand in 2024 were influential in the pullback in prices. China’s export figures increased by 8.7 percent in dollar terms in August, indicating the fastest growth since March 2022. This increase came as companies accelerated their Christmas orders and prepared for additional tariffs in the event of a possible election victory for Donald Trump in the US.
However, despite the strong export data, imports rose by only 0.5 percent, falling short of expectations and revealing weak domestic demand in China. OPEC has lowered its oil demand growth forecast for this year for the second time. OPEC expects oil demand to increase by around 2 million barrels per day this year. The new expectations are lower than the 2.1 million barrels forecast in August.
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