EY Malta Economic Update Q3 | 2022

A round-up of the Maltese economic landscape: Quarter 3| 2022

A deep dive into the interest rate movements and impacts  ...

As from March 2022, a number of central banks, including the Fed and the ECB, have embarked on a monetary tightening policy stance by increasing their reference interest rates and reducing their earlier Asset Purchase Programmes. Higher rates can control inflation (central banks’ often publicly stated main objective) by making it more expensive to borrow, spend and invest, thereby lowering aggregate demand for consumption, investment, and imports, and thereby GDP.

This concerted effort to curb inflation via interest rates is, however, raising concerns about their impact on economic growth, on the causes of inflation (cost-push, not demand-pull) requiring a different type of remedy package, and on the impact on different commodities and asset classes. Years of low rates had pushed investors toward riskier holdings, a process that is now going into reverse, while rising rates can lower the value of certain existing holdings. What do we know about how certain asset classes can be impacted?

• Cash: cash and cash-like equivalents (e.g. savings) benefit from higher interest rates on deposits.
• Bonds: investors in long-duration bonds are stuck holding a lower-yielding asset (i.e. bond prices go down) as interest rates increase.
• Equity: higher interest rates could see increased volatility and cost of borrowing, leading to price declines (not as much as bonds), with some investors selling off their holdings.
• Commodities: these tend to fall in price because of an increase in cost associated with holding inventories (oils, minerals, agriculture), or because of increased competition from higher-yielding investments (silver, gold). At the same time, the current energy crisis seems to indicate otherwise.
• Real estate: home ownership can become less affordable as mortgage interest payments rise, whilst income from rental property is likely to increase.

Locally, banks could be seen initially cushioning the impact of higher interest rates. In fact, interest rate increases by the ECB did not automatically translate into equal changes to the rates charged by banks. Local banks’ future base rate will be shaped by the overall size and pace of the ECB’s interest rate decisions, especially if interest rates remain high over the medium to long term.

Central bankers and other economists highlight the need for further interest rate hikes. Some analysts foresee only a half-point increase (i.e. 50 basis point increase) at the next rate-setting meeting in December 2022, after which the ECB is expected to take a pause. Currently above 10% in the Euro Area, the ECB predicts inflation will only fall to 2.3% by the end of 2024.

By comparison, the Fed is also expected to lift rates by 50 basis points, but peak policy rate may be higher[1]. US monetary tightening has had strong spill-overs on the rest of the world through the high level of the dollar. Indeed, the EUR-USD exchange rate must be kept in check - a weaker euro worsens inflation by raising the price of imported goods, whilst pushing hot money out of Europe into investments priced in dollars. According to ING, EUR-USD could be trading in a 0.95-1.05 range for most of 2023[2].

Reigning in inflation could, however, come at the cost of weakening output growth. Leading economists are in fact pencilling in a recession for the end of this year and the beginning of next year in both the US and the Eurozone countries. IMF forecasts that global economic growth will slow from 3.2% this year to 2.7% next year.

Cut-off date: 29 Nov 2022

EY Malta - Economic Advisory Services

EY’s Economic advisory services provides a full suite of economic services, helping both public and private sector clients understand the current and future environments they operate in, and facilitating scenario planning and decision-making.  Our services include:

• Cost benefit analysis and project appraisals
• Economic impact analysis
• Regulatory and policy economics
• Consumer demand analysis
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• Market structure and competition
• Modelling and forecasting

References