Global Daily – Euro bank lending channel functioning smoothly

by: Aline Schuiling , Georgette Boele

Euro macro: Further easing of banks’ credit standards – The ECB’s Bank Lending Survey for Q2 showed that banks continued to ease credit standards on loans to companies. The net percentage of banks that eased standards increased to 3%, following 2% in Q1. The forward looking part of the Q1 survey showed before that banks planned to tighten standards in Q2, but apparently they did not execute their plans. The forward looking part of the Q2 survey indicates that standards will be eased further in Q3. The main factor behind the easing of standards in Q2 was pressure from competition, but cost of funds and balance sheet constraints, as well as risk perception and risk tolerance also contributed to the net easing. In regard to loan demand, banks reported a further sharp increase in demand from companies (balance to +15%, up from +6% in Q1). Loan demand related to fixed investment and to M&A activity increased the most, whereas the use of alternative finance continued to have a decreasing impact on loan demand.

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The results of the BLS signal a further strengthening of bank lending growth. We expect loan growth to accelerate in the coming quarters. It should be fuelled by the ongoing economic recovery and the strengthening of fixed investment growth. On top of that, lending should be underpinned by the still low level of interest rates and the expectation that rates will probably rise in the coming quarters, as the ECB is gradually moving towards the tapering of its asset purchases. Indeed, the results of the BLS add to the evidence that the bank lending channel in the eurozone is functioning properly at the moment, which will strengthen the ECB in its view that it can start tapering its asset purchases as from the start of next year onwards.  (Aline Schuiling)

Global FX: Testing the ECB – Recently,  the less hawkish comments from Fed Chair Yellen and weaker than expected US economic data have weighed on the US dollar. Overnight, the debacle of the US healthcare bill has further deteriorated investor sentiment towards the US dollar. Currently, financial markets are clearly biased towards negative developments in the US and positive developments in the eurozone. As a result EUR/USD has risen above 1.1550 mainly because of narrowing yield spreads (real and nominal) between the US and the eurozone. The area between the current level up to 1.1714 (previous peak) is a very crucial area for EUR/USD. We expect that FX options-related activity will probably dampen the upward move somewhat. But if EUR/USD breaks above this previous high of 1.1714 the technical picture becomes more positive, pointing to much higher levels in EUR/USD. Up to the ECB meeting on Thursday, it is likely that investors will try to push EUR/USD higher to see how the ECB will react to this new reality. We expect Mr. Draghi to be dovish (also see our Global Daily of 17 July ‘Exit without a tantrum’ here) and this should limit the upside in EUR/USD or it could even trigger some profit taking on long euro positions. If, however, Mr Draghi is not dovish or seems unmoved by developments in foreign exchange markets, EUR/USD will most likely break above 1.1714 and our year-end 2018 target of 1.20 is within reach. (Georgette Boele)