Why rate hikes hurt more in Europe

HIKES: The European Central Bank (ECB) signaled last week it is likely done hiking interest rates. With the policy rate at 4.5%, and after ten hikes, Germany is in recession and regional PMIs are contractionary. Whilst the Bank of England (BoE) considers one final hike despite still some of the world’s highest inflation. This is in stark contrast to the US where rates have been higher-for-longer and the economy is still robust. US policy transmission is blunted by fixed rates and longer maturities. By contrast in UK and Europe it is quickened by higher debt levels, a reliance on bank lending, and floating rate debt. This different backdrop has hastened the economic slowdown.

BANKS: Europe’s banks are supersized relative to their economies and the US. They are more tightly regulated and better capitalized than transatlantic peers and did not see contagion from the fall of Credit Suisse or March US banks crisis. Bank loans are 80% of corporate financing, with the rest from the bond market. This split is reversed in the US. Banks have been tightening lending standards for a year and 43% of companies complain about the availability of capital. This is more than in the US despite its higher policy rates, as bond spreads tightened. Also, with Europe’s companies lower profitability and higher debt load, more are reliant on eternal funding.

HOUSEHOLDS: UK household debt levels are higher than in the US whilst European levels are much lower (see chart). The biggest consumer segment is mortgages. Unlike the US where a 30-year fixed rate mortgage is standard, there is huge variation across UK and Europe. But the average is a shorter-term 25-year term, with over 40% of these loans at a variable interest rate. Unsurprisingly those in Scandinavia, that have the highest property prices and variable rate proportions, have seen among the strongest house price falls, and outpaced US weakness. 

All data, figures & charts are valid as of 18/09/2023.