By Rufaro Chiriseri, Head of Fixed Income for the British Isles at RBC Wealth Management
As widely expected by market participants, the European Central Bank (ECB) left interest rates unchanged at 4%—the first pause after 10 consecutive hikes. The ECB statement on its inflation target remained largely unchanged from September, noting that “interest rates are at levels that, maintained for a sufficiently long duration, will make a substantial contribution to this goal.” During the press conference on Thursday, ECB President Christine Lagarde stated that “having a discussion on rate cuts is totally, totally premature.” We think this hints at a central bank that is increasingly subscribing to the “higher for longer” narrative, but prudently maintaining its data dependency to determine how long rates will remain at this level. The bond market reaction was more notable following the press conference, as German 2-year Bunds rallied before settling around 3.06%, while the euro against the U.S. dollar fell to an intraday low of 1.0525 from the prior day’s close of 1.0566.
The risk of a recession in the eurozone has increased and growth risks remain tilted to the downside, in our view, with recent preliminary economic activity data as indicated by the October HCOB Eurozone Composite Purchasing Managers’ Index (released on Tuesday) pointing to economic stagnation. All measures across manufacturing, services, and the overall composite fell short of the expectations of economists polled by Bloomberg, and reached further into contractionary territory. Economic activity from services has been a bright spot for GDP since the start of this year, but the sector posted its worst reading in nearly four years.
The Q3 euro area bank lending survey conducted by the ECB showed that higher interest rates are working their way through the economy, as evidenced by tighter financial conditions. Banks tightened their lending standards at a faster pace compared to their own forecasts, and this was mainly attributable to higher risk perceptions among respondents, lower risk tolerance, and lower liquidity positions. Meanwhile, higher interest rates, lower financing needs from corporations, weaker housing markets, and low consumer confidence led to weakness in demand for loans from households and businesses.