The interest rate hikes expected this year by the European Central Bank (ECB) could pose bigger problems, in addition to the already visible slowdown in the economy and the lower confidence of economic agents. According to a study by the Economist Intelligence Unit (EIU) published this week, continued monetary tightening could bring Italy down, triggering a new wave of financial stress, with contagion to several sovereign countries in southern Europe, in particular, “most debt”, warn the authors of the work entitled Global Monetary Policy in 2023.
Portugal is never directly mentioned in the investigation. Recently, the country has even been praised for having managed to reduce the deficit and public debt while showing some resistance to the consequences of the inflation and energy crisis. So far it has avoided a recession and looks set to escape it earlier this year. The same will not happen with different countries of the European Union (EU).
But EIU experts are still deeply concerned about southern European sovereigns, starting with Italy. According to the European Commission, Greece leads the ranking of government debt weight with a whopping 171.1% of gross domestic product (GDP). Italy comes second with 144.6%. Portugal is in third place with about 115%, closely followed by Spain with 114%.
“The eurozone is at risk of suffering a liquidation of its national debt,” shoots the research unit of the group The Economist.
“The tightening of financial conditions in the Eurozone will lead to a widening of government bond spreads. The ECB has announced that it will begin to run down its bond portfolio, worth €5 billion (quantitative tightening) at a pace of 15 billion euros per month from March 2023″, the experts begin.
“In recent years, the ECB has absorbed most of the new sovereign debt issuance, helping to shield governments from market pressures. With large budget deficits – while governments extending stimulus to cushion the impact of high energy – and rising borrowing costs, there is a moderate risk that investors will begin to lose confidence in the fiscal sustainability of some countries, especially highly indebted countries in Southern Europe, such as Italy,” they argue.
“This could trigger a strong sell-off in government bond markets, increasing the risk of financial market contagion.”
The EIU forecasts that interest rates in the eurozone and the US will continue to rise until mid-2024. Eurozone interest rates are currently at 2.5%, but will reach 4% later this year and remain at this level for at least a year, these analysts now say. Therefore, at best, interest rates should not begin to fall (and slowly) until the second half of 2024, the unit said.
If there is another very high inflation due to a sudden escalation of war or an unexpected bottleneck in raw material supply, the downward scenario projected for the end of 2024 may have to be postponed.
“At the beginning of 2023, the Federal Reserve (US) – or Fed – had raised its benchmark rate by 4.25 percentage points, and the ECB had raised its base rate by 2.5 percentage points,” but more hikes are on the way and “we expect both regions reach maximum interest rates by mid-2023,” the unit says.
“For now, we expect the Fed and ECB to manage inflation without triggering a deep global recession, but the risks are high,” experts warn.
Since July, the ECB has already raised interest rates (which have been at 0% for more than six years) to 2.5%. But according to the EIU, “We expect the ECB to raise the benchmark [refinanciamento] by 1.5% in 2023 (0.5% in February and March and 0.25% in May and June),” they say in the same study.
When they reach a maximum of 4% in mid-2023, the result of monetary tightening that is “more than double the pace compared to the last tightening cycle in 2005/2008”, “we expect interest rates in the Eurozone to peak levels for at least one year, with the first rate cut in the third quarter of 2024, in line with the Fed.”
As mentioned, Italy is perhaps the most delicate case, but the EIU notes that other economies are at risk. Spain for example. “Higher interest rates will increase the cost for companies to pay the interest on their debt” as “firms in Italy and Spain have a much higher share of debt at a floating rate and maturing in the short term than those of France and Germany.” and are therefore more likely to be exposed to the current ECB tightening cycle,” the economists conclude.
Something similar happens with indebted families. “Italian and Spanish real estate markets are among the most exposed in the region to ECB tightening, given the large percentage of mortgages with floating rate contracts.”
According to the ECB, only 25% of loans to households have a fixed interest rate in Italy and Spain, compared to about 90% in France and Germany.
The variable rate is also dominant and overwhelming in Portugal. The Bank of Portugal has already warned in its latest report on the financial stability of the economy that “the slowdown in economic activity and the rise in inflation, coupled with the rise in market interest rates, increase the risk of default by households” . and “the share of floating rate home loans is about 90%, leading to an increase in market interest rates that translates into an increase in debt service in the short term”.
Dinheiro Vivo journalist
Source: DN
