For central banks, a tool that ferments growth and stabilizes prices cannot be treated as mere help for households and businesses. It is a mechanism that, when misused, can undermine income, and it acts like a persistent force. High interest rates are a constraint that must be managed, while they influence inflation and the cost of borrowing. For governments, the dynamic is double-edged: keeping inflation in check helps control spending on pensions and social programs, yet higher rates raise the expense of servicing public debt.
Recently, central banks have raised interest rates swiftly, cooling economic momentum. The narrative spans 2022 into 2023 and points to more pronounced effects through 2024. Analyses from national authorities indicate that rate hikes subtract growth from the economy and temper employment and investment, with estimates suggesting that the GDP growth trajectory could have been stronger absent tighter policy.
While the impact on loans, growth and inflation remains substantial, warnings persist that the effects will unfold over time. The leadership of major institutions has often noted that the full impact of rate changes tends to arrive gradually, with peak effects sometimes extending over multiple years. In the broader framework, a central bank’s actions tend to shift inflation dynamics over a multi-year horizon.
Lower growth, slower inflation
Since mid-2022, the policy rate in the euro area rose markedly, reaching levels not seen in decades. This pace is unlikely to reverse quickly, as inflation remains stubborn and policy aims to anchor expectations. Analysts anticipate that the first rate cuts, if any, will come only in the latter part of a multi-year horizon.
Institutions running macroeconomic studies project that this tightening reduces inflation in the near term and gradually eases price pressures in the medium term. Projections suggest inflation averages might settle lower this year, with a path of recovery if supportive policies are removed or adjusted.
On the growth front, several forecasts indicate a slower expansion pace compared with earlier projections. The tightening is expected to shave fractions of a percentage point from annual growth in the coming years, while long-run outcomes depend on the evolution of policy and external conditions. In a scenario without tighter monetary conditions, growth could have been more robust, but the governing objective remains price stability and sustainable employment.
Across the euro area, official rate trajectories are seen as gradually easing over time, with inflation returning toward the target in a multi-year process. International organizations estimate that history shows inflation-fighting efforts typically span several years before a durable lull is achieved.
Four links in the monetary transmission chain
The monetary policy sequence comprises several steps. First, the official rate increases. Second, borrowing costs rise for loans and mortgages. Third, households and firms adjust spending and investment in response. Finally, weaker demand helps ease price pressures and inflation moderation follows.
First link: the policy rate
Since mid-2022, both the European Central Bank and other major authorities have pushed policy rates higher, keeping the money cost elevated for an extended period. While discussions about further moves continue, many observers see a plateau rather than an immediate downturn. Institutions emphasize patience, warning against premature rate cuts while inflation risks remain.
Second link: higher borrowing costs
Banks have tightened lending standards, and the demand for financing from households and firms has cooled. Lending metrics reflect stricter criteria, higher interest charges, and longer maturities. Amid these shifts, credit supply and demand have shown signs of moderation, with some markets experiencing slower credit growth as the policy stance persists.
Across regions, loan pricing has risen, with mortgage and business credit costs moving in response to the increased policy rate. The magnitude of pass-through varies by loan type, but the general trend points to higher borrowing costs across the board.
In Spain, for example, the average mortgage rate has climbed since late 2021, while lending to households and corporations has expanded at a slower pace, influenced by tighter criteria and rising financing costs. The aggregate effect is a cooling in credit expansion, rather than a sudden stop.
Importantly, the amount of credit extended to the private sector has risen more slowly, and prospective lending tends to be more cautious as conditions tighten. Analysts expect loan growth to resume only after a period of stabilization and adjustment in the broader economy.
Third link: households and firms curb spending
As financing becomes more expensive, disposable income allocation shifts. Banks have reported a downshift in new lending, including mortgages, while consumer and corporate credit shows mixed patterns. Overall, the private sector balance has tightened, with forecasts pointing to modest or negative growth in new lending through the near term.
From a broader perspective, housing markets and business investment respond to higher financing costs, contributing to slower activity in construction and related sectors. Projections indicate a prolonged period before loans regain momentum, unless supportive policy changes or favorable external factors materialize.
There is a clear linkage between tighter financial conditions and the moderation of activity in several sectors, including real estate. Price dynamics in housing show steadier rises, reflecting cautious demand and prudent lending standards as the monetary stance remains restrictive.
Fourth link: inflation cools over time
Tighter financing and reduced demand contribute to easing inflation pressures. Yet wage dynamics and supply conditions can complicate the path toward the 2 percent objective. Labor markets may experience tighter conditions, potentially sustaining wage growth that offsets some of the cooling from monetary policy.
In the United States, strong employment and robust output growth in recent quarters exert upward pressure on wages in some sectors. The ongoing process of bringing inflation down toward target levels involves balancing resilient demand with cooling measures, a delicate task that requires careful policy calibration.
The overall outlook remains contingent on geopolitical developments and commodity prices. While policy frameworks succeed in dampening inflation, external shocks and energy costs can reassert upward pressures, reminding observers that the inflation battle is rarely finished in a single season, but rather through steady, responsive action over time.