BusinessToday Previous Editions

10 ANALYSIS 23.2.2023 THE European Central Bank has a handy flowchart to explain how it sees monetary policy ultimately feeding through to prices. e four main transmission chan- nels are: money/credit, asset prices, bank rates and the exchange rate. All four channels have seen sizable adjust- ments since last summer: The money supply has fallen quick- ly since the ECB started reducing as- set purchases. In fact, growth in real money (M1) has not been so negative since the ECB's record-keeping began. This historically corresponds with a significant correction in economic ac- tivity. When looking at asset prices, stocks and bonds saw a significant correction in 2022 (although we have seen a re- bound in prices as expectations of a peak in policy rates have grown this year). Real estate prices are somewhat slower to respond but are undoubtedly starting to turn. In countries like Germany and the Netherlands, price declines have al- ready become somewhat sizable as the combination of higher bank rates, low consumer confidence and lower pur- chasing power is resulting in declining housing demand. is is not where it will stop. is is expected to have an impact on construction activity in the coming year. Bank rates have also considerably in- creased since the beginning of 2022, following the increase at the longer end of the yield curve. is is starting to curb investment as growth in bank lending has almost stalled for house- holds and is considerably negative for businesses. Traditionally, business borrowing reacts with longer lags to higher rates than consumer borrowing. Last year, for example, borrowing by non-finan- cial corporates held up until mid-2022 because of working capital needs – due to supply chain problems for exam- ple. Recently, however, there has been a sharp correction, which has been much quicker than in previous cycles. at correction corresponds to the Bank Lending Survey, which indi- cates that borrowing needs for invest- ment reasons have fallen significantly in recent months. is is expected to have an important dampening impact on investment in the eurozone in the quarters ahead, although the recovery fund's impact on southern economies could mute the overall investment re- sponse seen in 2023. e euro has appreciated since the end of last year as investors are ex- pecting more rate hikes from the ECB and because energy prices have fallen significantly from the peak which has resulted in a smaller trade deficit. is is starting to feed through to import prices, which have started to see lower year-on-year growth. In fairness, the bulk of that move down has resulted from the lower energy prices seen recently, but the impact of a stronger euro will be felt down the line. No need for TPI as monetary transmission is not showing signs of fragmentation When looking at the above-defined categories per country, we see that there is not that much difference in transmission. e rise in percentage points for borrowing rates differs just modestly between countries and the nominal ef- fective exchange rate has made roughly similar movements for most countries – as expected. Liquid assets have seen declines across the board, with a few stock mar- kets in Southern Europe notably out- performing. House prices are still well above levels seen in late 2021, although Germany and the Netherlands are starting to see a correction as a down- ward trend has started which the table below does not pick up on. e money supply is of course han- dled centrally, but recent develop- ments in bank lending can say some- thing about credit reaching the real economy. Here, we see the most strik- ing difference so far, as Italy and Spain have seen declines in borrowing from non-financial corporates, whereas Germany and France have not, yet. e important caveat here is that we have seen quite some borrowing for working capital and inventory reasons, which has driven up borrowing or at least made borrowing more volatile. For Germany, the bank lending survey suggests declining demand for invest- ment borrowing, which means that transmission could be at work more than the numbers suggest. Compared to the average, France is How the ECB's rate hikes are filtering e European Central Bank's policy stance has become restrictive. e impact on the economy is probably the most underestimated drag on growth for 2023. e good news is that there are no meaningful signs of fragmentation between countries, so monetary policy is not causing shocks in more vulnerable parts of the eurozone ECB's own take on monetary transmission The early phase of monetary transmission is fast at work

• Cover