Market participants are concerned that the wire will break at some point. Mathematically everything is simple. When expenses (the rise of interest rates plays an important role here) grow faster than income (the increase in wages, which has such, certainly lags behind inflation), then if you add both indicators from time to time, the trend of the results is negative and this cannot continue for a long time without consequences, i.e. reduction of expenses . Expectations of spending cuts lead to forecasts of a slowdown in economic growth, or even a recession and a halt in price growth. But in life, everything is different, and the eurozone economy has started the year with more positive than negative surprises in terms of growth.
Labor market is strong, growth better than previously forecast. The stock of positive news for consumers is supplemented by the news that this week the price of oil dropped below 75 dollars per barrel, the price of gas approached 40 euros per MWh, compared to a year ago, the prices of metals, logs, wheat and other raw materials are now lower on the global market.
Despite the relatively rapid drop in raw material prices, the overall inflation rate is decreasing more slowly than desired and it is still well above the targets set by the central banks. That is why, despite the fact that there are “cracks in the wire” here and there in the financial market (“Silicon Valley Bank”, “Signature Bank”, “Credit Suisse”), the central banks are unlikely to change their bellicose stance on interest rates.
The events of the last week in the banking sector significantly influenced the opinion of market participants about the future of interest rates, as a result of which the 1-year Euribor interest rate experienced the largest one-day declines since 2001 on March 14 and 16. The rate fell 34.9 basis points (bp) on Tuesday, recovered 15.3bp on Wednesday and then fell 30.3bp on Thursday.
Until now, the record for a one-day drop was recorded on September 18, 2001 -20.9 points (a drop after the central banks’ response to the events of September 11). The 49.9bp drop in the 1-year Euribor rate over three days suggests that market participants have ‘switched off’ the ECB’s promised 50bp hike ahead of the ECB meeting. But is a change in market participants’ views on the behavior of interest rates justified? According to the ECB’s actions, it looks like it is not, and in the coming days at least some of the reduction in interest rates of the last few days will be lost.
The decision of the ECB this time is as promised in February: “The Council decided to increase the three main interest rates of the ECB by 50 basis points. Thus, the interest rate of the main refinancing operations, as well as the interest rate of overnight lending facilities and the interest rate of overnight deposit facilities will be increased (to 3.50%, 3.75% and 3.00%, respectively) starting from 22 2023. March.”
The answer to market participants’ concerns about the situation in the banking sector is: “The Council is closely monitoring the current market tension and is ready to take the necessary countermeasures to preserve price stability and financial stability in the eurozone. The euro area banking sector is resilient and its capital and liquidity position is strong.”
The European Central Bank also published the latest GDP and inflation forecasts this time. Taking into account the latest data, inflation forecasts are slightly lowered, but GDP forecasts are raised for this year (the ECB does not forecast a recession), but slightly lowered for the next couple of years. Is a prolonged period of slow growth expected?
Conclusions for loans
In recent days, there has been a “deceptive” decline in interest rates, as the previously mentioned “gaps in the wire”, or the problems of some banks, are what led to hope that central banks will soften their stance and that the rise in interest rates could be in sight. Expectations were not met.
There is still a “tail” in the market with loan payments that have not seen positive interest rates. A month remains until the first day of the year of positive 1-year Euribor. Last year, the 1-year Euribor entered positive territory for the first time on April 12, but since April 21, the rate has not returned to negative territory. This means that the first positive rate invoice has not yet been received by those borrowers whose contract mentions 1-year euribor and the next interest rate change is in the coming weeks. The rest of the credit market is already suffering from the record pace and amplitude of euro interest rates.
European banks are much stronger than in 2008. Derivatives transactions have decreased significantly, as well as a number of risky transactions are now carried out with cash collateral, which reduces the risk of loss. That is why the market, despite the mistakes of some market participants, is stronger and the central bank feels more comfortable in raising interest rates in the fight against inflation, as a result of which the head of the ECB stated that she does not yet see where the top of interest rates would be. This is bad news for loan interest payments.
What other conclusions
On March 16, we marked one year since the US FRS started raising interest rates. The next US FRS meeting is on 21/22. in March. Although the turmoil in the financial market in recent weeks suggests that it is a signal of problems caused by the actions of central banks, these problems are segmented (more errors in managing the maturity and liquidity risk of specific market participants than systemic errors) and have not infected the economy.
Looking at account balances in Latvian banks, we can see that account balances continue to grow on an annual basis. It is somewhat worrying that the rate of growth of household account balances is slowing down (which is a logical consequence of rising interest rates and high inflation). It is good that company account balances are still growing relatively fast – there are reserves. This is good news for the Latvian economy. Now these reserves must be put to use.
The assertive behavior of central banks has also reassured investors and stock markets are generally behaving relatively well. However, price swings may be high for a while while the market calms down from the events of the previous weekend. Caution should be maintained anyway, because I already wrote about mathematics.
