Is the ECB's rate-hiking cycle nearing its end? Both supply and demand for bank credit in the euro area are weakening, and signs of an economic slowdown are testing the future interest rate path.

The ECB pointed out that euro area banks tightened credit conditions in the third quarter and reported weakening loan demand. This further supports the ECB's stance of caution regarding further rate hikes. The ECB stated that increased risk perception and reduced risk tolerance among lenders remain the main reasons for banks tightening lending standards. Some banks found that pressures from geopolitical uncertainty and energy market volatility are intensifying. Euro Area Credit Conditions Tighten The ECB stated in its Bank Lending Survey published on Tuesday: "The overall level of interest rates is the main factor dampening loan demand. Weakening fixed investment demand among small and medium-sized enterprises, as well as firms shifting to other financing channels, have also weighed on loan demand to some extent." The survey comes as the ECB is about to hold a two-day monetary policy meeting. Markets expect the bank to keep rates unchanged. Although inflation is close to twice the 2% target and the economy has shown resilience, the recent sharp rise in long-term bond yields, combined with factors such as the Middle East war, are bringing more headwinds to the economic outlook. Bank lending plays a key role in driving economic activity, especially corporate investment. At the same time, lending conditions are also a leading indicator of how monetary policy affects economic growth. Since June, the ECB has raised borrowing costs twice, bringing the deposit rate to the upper end of the range considered neutral for the economy. Rising Rates Lead to Lower Loan Demand in the Euro Area Another report published by the ECB on Monday found that firms believe credit costs are rising, and the decline in loan availability exceeds what their demand would explain. In addition, Tuesday's report showed that over the past year, the ECB's balance sheet reduction has had a "slightly negative impact" on banks' market funding conditions and liquidity positions. The report said: "The impact on bank profitability is slightly positive, with higher net interest income partially offsetting small capital losses. Banks expect these effects to persist over the next 12 months." David Powell, senior euro area economist, said: "The ECB's survey shows that both credit supply and demand are weakening in the face of uncertainty from the Middle East war and rising borrowing costs. At this week's meeting, dovish members of the ECB Governing Council will use these survey results to argue that the rate-hiking cycle should end soon." However, the ECB said banks observed gradually but consistently growing demand for loans to finance artificial intelligence (AI) infrastructure construction. The report said: "Most banks indicated that they have not yet introduced specific quantitative criteria in their credit standards for assessing AI-related loans. A few banks noted that the application of AI and its associated risks are becoming increasingly important in the qualitative assessment of borrowers, with information technology firms subject to the strictest scrutiny." It is worth noting that, in addition to the two reports from the ECB, weakening economic growth momentum also supports the ECB's cautious stance on further rate hikes. The latest surveys show that data to be released this Friday will show that euro area economic growth in the third quarter may slow to 0.2% from 0.6% in the second quarter. Meanwhile, several other surveys show that inflation rates in the four largest euro area economies did not show a clear broad-based upward trend in October. The European economy, which has shown strong resilience since the outbreak of the Middle East war at the end of February, may be starting to lose momentum, and business activity is also beginning to show signs of fatigue. During the third quarter, European economic output was hit by multiple factors, including summer heatwaves, low water levels in major waterways, and surging global bond yields. Since then, the overall environment has further deteriorated, with France facing large-scale protests and growing questions about its public finances. The surge in energy prices triggered by the Middle East conflict is putting pressure on euro area inflation. However, policymakers emphasized that they have not yet seen second-round effects such as wage increases. Some officials, including ECB Chief Economist Philip Lane, said that a "measured" policy response should be sufficient to restore price stability. ECB President Lagarde previously said that high inflation in the euro area driven by high energy prices has not yet been transmitted to the broader economy. She said ECB officials are assessing "how much indirect impact is being transmitted through the economy and how we can best judge ahead of time if second-round effects begin to emerge." Bank of France Governor Emmanuel Moulin also took a stance on inflation similar to Lagarde's. He said the ECB expects "indirect effects and second-round effects will remain contained," and that euro area core price indicators will only accelerate "modestly." Slowing economic growth and inflation pressures that have not further deteriorated may have reduced the urgency for the ECB to act. For economists, this means the ECB may wait until December to raise the deposit facility rate for the third and final time, rather than hiking this week. This judgment stands in sharp contrast to market bets on several more hikes to cometraders expect the ECB to raise rates three more times over the next year.