12° Nicosia,
18 July, 2024

Inflation fears and green investments

A recap of the top stories that shaped the week


ECB Revises Inflation Forecast

The European Central Bank (ECB) has revised its inflation forecast upward, now predicting that inflation will reach 5.6% in 2023 and 3.2% in 2024. This change is attributed to projections for the price of oil and other energy products. The convergence with the 2% inflation target is now expected by 2025, stabilizing at 2.1%. It's worth noting that inflation, which reached a record 10.6% in October 2022, was estimated at 4.3% in the previous month. Factors contributing to this moderation include a better balance between supply and demand and a decrease in energy costs.

Focus on Fiscal Policy

For many years, the Eurozone operated with deficits funded at near-zero interest rates while economies flourished. However, interest rates are now expected to rise above growth rates, making borrowing unsustainable for the foreseeable future. Investors are seeking new fiscal regulations to restore confidence in European government bonds. In the coming period, fiscal policy and new fiscal rules are expected to be a focal point of economic reporting, marking a significant shift from the previous emphasis on monetary policy.

Attention to Default Risks

As expected, the rapid rise in interest rates has expanded banks' profit margins while increasing concerns about deteriorating asset quality due to loan servicing difficulties. In light of this concern, supervisory advice leans towards an immediate assessment of loan loss expectations. Simultaneously, risk management systems and procedures need updating to ensure compatibility with today's challenges. Overall, while awaiting worsening data, banks are urged to implement early warning systems for better risk control.

Ambitious Investment Programs

In the near future, banks will need to undertake ambitious investment programs to improve their technological capabilities. Challenges posed by the emergence of non-bank institutions (fintech) are evident, and pressure for alternative offerings in traditional banking services is expected to persist. Additionally, banks must become more efficient in their operations by eliminating unnecessary costs. This process, although initially demanding substantial resources, is expected to allow banks to become more attractive to investors and achieve improved valuation metrics, providing greater value to their shareholders.

The Urgency of Green Transition

We cannot delay the green transition. Studies have shown that any delay will increase the cost of the transition that needs to happen anyway. Based on the results of extreme scenario simulations conducted by the ECB, if the green transition is delayed beyond expectations, the most vulnerable Eurozone banks will exhibit twice the losses in their loan portfolios compared to the interim observation of the sample. We must not relax our aspirations for the desired climate outcome because, in such a scenario, it will diminish the incentive for businesses to invest, even if the consequences of the climate crisis remain destructive.

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