ECB blog: Euro area credit recovery remains sluggish

Since the European Central Bank (ECB) began cutting rates in June 2024, credit to the private non-financial sector in the euro area has seen a gradual recovery.

However, this recovery is notably slower and weaker compared to most previous easing cycles, as detailed in a recent ECB blog post.

The analysis introduces the credit-to-GDP gap as a key metric to assess whether current credit growth meets the broader economy's needs.

A negative gap indicates that firms are borrowing less than expected given economic conditions.

While traditional frameworks might suggest a larger negative gap, the authors' preferred structural framework, which incorporates a broader set of macroeconomic relationships, indicates a significantly smaller, yet still negative, current credit gap.

This suggests that the pass-through from policy rates to credit, and ultimately to the real economy, has been somewhat weaker than in the past.

The persistent negative credit gap is driven by both cyclical and structural factors.

Cyclically, the lingering impact of the 2022–23 monetary tightening cycle, higher risk perceptions, and elevated bank funding costs continue to restrain lending.

Direct lending to non-bank financial institutions has increased, partially substituting firm credit, but non-bank financing has not fully offset the shortfall.

Structurally, shifts in consumption towards services, firms' growing investment in intangible assets (reducing collateral), and demographic trends that dampen demand for housing and durable goods collectively weigh on credit demand.

The authors warn that 'The financial system faces a choice between manageable adjustment costs today and potentially severe disruption tomorrow,' emphasizing the critical balance for future financial stability.