Higher rates generally benefit bank profits but the upside is fading, says Moody’s Investors Service in a new report.
Last week, the European Central Bank (ECB) boosted its key rate by 25 basis points to 4.25%, marking its ninth rate hike in the past 12 months.
Moody’s said the rate increase is positive for banks’ profits, “but the incremental benefit will be more limited than with past rate hikes because of lower demand for loans and higher funding costs for banks.”
Both supply and demand for loans is expected to decline as financial conditions continue to tighten. Moody’s said that banks are expected to tighten their credit standards given the more challenging economic conditions.
At the same time, it noted that the latest ECB lending survey pointed to “broad-based weakening in demand for loans.”
“Demand for corporate loans hit an all-time low in the second quarter,” it said.
Additionally, the latest rate hike will boost banks’ funding costs more than previous ECB actions, Moody’s said.
“The cost of deposits is also rising and could intensify going forward owing to larger shifts to interest bearing deposits (higher deposit beta) from sight deposits against a backdrop of stronger competition between banks, with some differences between countries,” it said.
Looking ahead, the latest communication from the ECB suggested that further rate moves are data dependent — including the evolving inflation outlook and underlying inflation trends, Moody’s noted.
“However, the ECB reported that interest rates will remain sufficiently restrictive until inflation returns to its medium-term target of 2%,” it said.