Commentary: The impact of inflation on the lending business

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The founding of the United States of America is closely associated with the phrase “no taxation without representation”. Nowadays, on the other hand, Milton Friedman’s phrase “inflation is taxation without representation” applies more and more. Inflation is, so to speak, an unofficial tax increase.

In November, inflation in the USA rose to 6.8% – a higher value has not been recorded since 1982. As a reminder, 1981/1982 saw the biggest recession since the Great Depression.

In the Eurozone, inflation is currently at 4.9% (for comparison: Germany 5.2%). Then, as now, there was talk of raising interest rates to fight inflation. While the ECB was content at its meeting on 16 December to drastically reduce its bond purchases and leave key interest rates untouched, the Fed has already held out the prospect of several interest rate increases in 2022 up to 0.9%. Securities purchases are also to be reduced by $30 billion per month from mid-January.

What does this mean for the eurozone credit market – especially for the new year 2022?

As long as the ECB continues to its plan to react only when inflation is above 2% in the medium-term projection horizon and leaves key interest rates unadjusted until then, these are clear incentives for companies and private individuals to borrow money.

The demand for credit is favoured by further increases in real estate prices in many countries of the Eurozone, with demand for real estate not diminishing. This leads to growing credit volumes. There may also be increased demand precisely because of the expected future movement in key interest rates, as potential borrowers want to secure cheap loans in good time.

Banks and other credit providers will therefore be confronted with increased demand, but at the same time they must keep an eye on the increasing risks due to the necessary follow-up financing. Due to the low interest rate level and the tendency towards higher loan amounts, even a slight increase in the nominal interest rate by only one percent has a strong impact on the monthly instalment of the follow-up financing.

In conclusion, it can be said that not only the states benefit from “taxation without representation”, but also debtors and even creditors – as long as debtors continue to demand loans and the loans do not default.

Info: Our author Christian Piller is Product Director Banking at Collenda and responsible for Loan Origination.

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