Jan. 18 (Bloomberg) -- European banks say they will make it harder for companies and consumers to get loans in the next three months, weakening the case for further interest rate increases.

The European Central Bank's survey of 89 financial institutions showed that banks' willingness to lend ``is expected to continue to be affected over the next three months'' by ``turmoil'' in financial markets. Banks also expect ``difficult'' wholesale funding conditions to continue, the Frankfurt-based ECB said today in a report published a month earlier than usual.

The ECB left its main rate unchanged at 4 percent last week on concern fallout from a U.S. subprime loans crisis will derail Europe's economy, preventing it from acting against faster inflation. Today's report suggests banks are keeping a grip on their funds even after the ECB loaned them a record 348.6 billion euros ($510 billion) on Dec. 18 to end a logjam in money markets.

While the bank has so far refused to follow the Federal Reserve and the Bank of England in cutting rates, a slowdown in lending is threatening to hurt company investment, a plank of Europe's economy last year.

``This is a further nail in the coffin of the ECB's plans to raise rates,'' said Marco Kramer, co-head of European economics at Unicredit Markets & Investment in Munich. ``The ECB just can't blindly focus on inflation concerns, it has to take into account slowing growth. And this is further evidence.''

The Frankfurt based-bank expects growth in the 15-nation euro region to slow to about 2 percent this year from 2.6 percent in 2007, according to its December projections.

Wage Demands

ECB President Jean-Claude Trichet and fellow council member Axel Weber say their room for maneuver is limited because higher wage demands are raising price risks. Inflation, which the ECB aims to keep below 2 percent, held at 3.1 percent in December, the fastest in more than six years. The bank says it will average about 2.5 percent this year after 2.1 percent in 2007.

Higher credit costs will this year crimp company investment, the Munich-based Ifo institute said Dec. 12. It expects company spending on equipment in Germany to grow about 4 percent this year after increasing 9.2 percent last year.

Banks' reluctance to lend will probably also hurt parts of Europe's housing market. Demand for mortgage loans dropped ``considerably'' and was ``significantly negative'' last quarter, the ECB said.

Balance Sheets

Banco Santander SA, Spain's largest bank, said yesterday Spanish mortgage-lending growth may slow to 5 percent this year. A report by the country's mortgage association last week said housing loans grew 17 percent in the year through October, the slowest pace in more than a decade.

Financial institutions are trying to protect their balance sheets after the jump in credit costs made it more expensive for them to raise money. While market borrowing costs have dropped since the world's central banks announced a series of money auctions last month, they are still higher than usual.

The three-month Euribor rate fell to 4.41 percent today, 41 basis points above the ECB's benchmark, after rising to a seven- year high of 4.95 percent in December. That compares with the average 25 basis-point gap recorded in the first half of 2007.

``We're still in a banking turmoil, which is still confined'' mainly ``to the financial sector,'' ECB council member Yves Mersch said in an interview published Jan. 16. ``We have to get greater clarity before we can see what amount of the potential will really affect the real economy.''

`Slightly Positive'

Grafton Group Plc, Ireland's biggest builders merchant, said Jan. 4 that ``increased interbank interest rates,'' have resulted in ``an increase in the full-year interest charge for 2007.''

Banks have already announced more than $100 billion of writedowns and both Citigroup Inc. and Merrill Lynch & Co. reported record losses this week.

Net demand for company loans was ``slightly positive'' in the fourth quarter, ``albeit declining further,'' from the previous quarter, today's report says.

``I don't really think we will see a full blown credit crunch, where banks are not giving companies money,'' said Michael Schubert, an economist at Commerzbank AG in Frankfurt. ``If there is a drop in company investment that is more related to slowing economic growth, rather than a lack of available funding.''

To contact the reporter on this story: Gabi Thesing in Frankfurt gthesing@bloomberg.net

Last Updated: January 18, 2008 07:28 EST