“Searching for (any) positives”

Wealth effects and HH consumption in the EA

The key chart

**Household net worth is at a new high driven by persisent financial surpluses post GFC combined with positive revaluation effects from housing and financial assets (multiple of disposable income)**
Source: ECB; Haver; CMMP analysis

Examining wealth effects

Households (HH) in the euro area (EA) have been running persistent financial surpluses of between 2-3% GDP since the GFC. I considered the implications of these trends for the choice of policy mix in previous posts (see “Policy reboot 2020”). In this post, I examine the implications for the resilience of HH consumption in the face of the Covid-19 crisis.

**HHs have run persistent financial surpluses since the GFC leading to a build up of financial assets (% GDP, 4Q sum)**
Source: ECB; Haver; CMMP analysis

HH net wealth (HNW), the difference between the value of HH assets and liabilities, is an important determinant of private sector consumption. Given that HH consumption accounts for 54 cents in every EURO of GDP, it is also an important determinant of overall GDP growth in the EA.

Changes in wealth affect consumption in the short run as HH feel richer or poorer and become more or less confident. The level of HNW is also an important driver of long term consumption since, along with income from employment, it determines the amount of economic resources available to HHs.

**Trend and breakdown (NFAs, FAs, FLs,) of HNW over the past twenty years (EURO trillion)**
Source: ECB; Haver; CMMP analysis

HNW hit a new high in absolute terms (€52trillion) and as a multiple of disposable income (7.2x) at the end of 3Q19. This included non-financial assets (NFAs) of €34trillion, largely in the form of housing, and financial assets (FAs) of €26trillion, netted off against financial liabilities (FLs) of €8trillion.

**Breakdown of changes to HNW highlights the importance of revaluation gains in NFAs (change in Euro per capita)**
Source: ECB, Haver, CMMP analysis

The growth in HNW reflects not only the build-up of FAs, but also revaluation gains in these and other NFAs. As discussed in “Fuelling the Fire”, Quantitative Easing has stimulated asset prices and led to increased housing and financial wealth (see graphs above and below).

**QE has stimulated asset prices and increased housing and financial wealth (changes in per capita terms by quarter and as rolling 4Q sums)**
Source: ECB; Haver, CMMP analysis

Revaluation gains of NFAs have been particularly important in Portugal, Greece, Spain, Germany and Austria. However, ECB estimates suggest that while residential property prices remain undervalued in Greece, they were overvalued by 12%, 16% and 18% in Portugal, Germany and Austria respectively even before the impact of Covid-19 as felt.

**Property prices were over-valued even before the impact of Covid-19 (3Q19)**
Source: ECB; Haver; CMMP analysis

Potential revaluation losses on NFA will have a negative impact on HNW for obvious reasons, but their impact on future consumption (marginal propensity to consume) is more challenging to determine (and varies between micro and macro levels).

To summarise the very extensive economic analysis in this area, the long-term housing effects on consumption are consistently weaker than those of financial wealth. Indeed, in a recent analysis of larger EA economies, the ECB concluded that, “Spain is the only large EA country for which consistently positive housing wealth effects have been estimated.”

HHs in the Netherlands, Belgium, Italy and France have higher gearing to changes in FA values
Source: ECB; Haver; CMMP analysis

Significant heterogeneity exists in terms of the size and structure of HH financial assets. FAs are 2.2x the size of EA GDP on average, but above average in the Netherlands (3.6x), Belgium (3.0x), Italy (2.5x) and France (2.4x). Higher gearing to the value of financial assets in these economies is offset by the “absolute cushion” of higher per capita FA holdings in the Netherlands (€167k), Belgium (€121k) and France (€86k). However, in aggregate, Italian HHs have higher gearing than average but lower than average holdings of FAs per capita (€72k versus the EA average of €75k). Other Southern European economies also have smaller cushions in terms of FAs per capita – Greece (€25k), Portugal (€42k) and Spain (€50k).

**Liquid assets are an important part of HH total FAs especially in Greece, Portugal, Austria, Germany and Spain.**
Source: ECB; Haver, CMMP analysis

FAs consist mainly of liquid assets (currency and deposits) and pension and life insurance-related assets. These assets account for 70% of total HH FAs with the remainder held in higher risk products including equity, debt and shares in investment funds. The share of higher risk assets has fallen from 40% pre-GFC to 30% currently suggesting that the negative impact of recent market falls may be less than after the GFC. In addition, HHs in Greece (59%), Portugal (44%), Austria (40%), Germany (40%) and Spain (39%) hold higher amount of their financial assets is liquid assets. However, on a per capita basis, the largest liquid holdings are in Belgium (€38k), Austria (€33k), Germany (€31k) and Ireland (€31k).

Conclusion

The stock of HH wealth in the EA has risen to new highs in absolute terms and as a multiple of disposable income and represents an important economic resource in the face of the Covid-19 crisis.

Revaluation gains of both NFA and FA assets have been important drivers of recent HNW growth, but both will turn sharply negative in the current environment. At the macro-level, long term housing effects on consumption difficult to measure but are consistently weaker than those of financial wealth (with the exception of Spain).

HHs in the Netherlands, Belgium, Italy and France have relatively high gearing to changes in the value of FAs, although with the exception of Italy this is offset by relatively high per capita holdings on FAs. HHs in Southern European economies typically have lower “cushions” in terms of per capital holdings of financial assets.

Since the GFC, there has been a de-risking of HNW holdings away from debt, equity and shares in investment funds in favour of liquid assets and pension and life insurance related assets. Lower risk assets now account for 70% of HH FAs. In addition, HHs in Greece, Portugal, Austria, Germany and Spain hold relatively high amounts of FAs in liquid assets. This suggests that the MPC from financial effects may be lower than after the GFC.

These conclusions come with the obvious caveat that the impact of changes in wealth on HH consumption differs substantially between countries, between NFAs and FAs and between HHs within the same country.

Please note that the summary comments above are extracts from more detailed analysis that is available separately

chris@cmmacroperspectives.com

“Fiscal, first and foremost”

Extra time required in the euro area

The key chart

**The ECB revised down its outlook for growth and called for “an ambitious and collective fiscal response”** **(December 2019 forecasts (o); March 2020 forecasts (n))**
Source: ECB; CMMP analysis

A crucial week – part 2

On Thursday 12 March 2020, the President of the ECB, Christine Lagarde made a clear call for a policy reboot in the euro area. Unsurprisingly, Madame Lagarde presented a downbeat assessment for economic activity in the region. GDP forecasts were revised down to 0.8% (from 1.1%) for 2020 and to 1.3% (from 1.4%) for 2021 and left unchanged at 1.4%. Inflation forecasts were unchanged at 1.1% for 2020, 1.4% for 2021 and 1.6% for 2022 although downside risks were acknowledged notably from lower oil prices. (These new forecasts do not reflect the potential impact of the Coronavirus fully, due to their timing.)

Prior to the meeting, expectations had included a -0.1% cut in the deposit facility rate to -0.6%, a lending facility and a boost to QE (FT, 2020). The ECB did not deliver on the former. Instead, they announced a package of measures including a further €120bn of bond purchases and more cheap loans for banks. But, and more importantly, the key message was extremely clear – Madame Lagarde highlighted that the appropriate and required response to the current growth shock “should be fiscal, first and foremost.” In the Q&A session, she also noted that the fiscal measures already announced totalled only €27bn ie, a quarter of 1% of the GDP for the EA…adding:

“…hence, we are calling for an ambitious and collective fiscal response.”
Christine Lagarde, President of the ECB. 12 March 2020

The UK delivered in the first half

This was a crucial week for policy makers in Europe. The UK delivered with the “largest sustained fiscal loosening since the pre-election budget of March 1992” combined with a coordinated package of measures from the Bank of England.

“Mais, en attendant…”

To repeat – does it make sense to run tight fiscal policy (1) at this point in the cycle and in the face of weakening global growth and (2) when the private sector is running persistent financial surpluses? **(4Q sum of financial balances, % GDP)**
Source: ECB; Haver; CMMP analysis

As feared, the European response has been more limited and insufficient. Madame Lagarde was correct in her assessment of the required response, but the second half of this crucial week ends ultimately in disappointment. Extra time is required…

Please note that the summary comments above are extracts from more detailed analysis that is available separately

chris@cmmacroperspectives.com

“Sustained fiscal loosening”

UK budget from a sector balances perspective

The key chart

**“A major policy shift to sustained fiscal loosening” – current OBR forecasts for the UK budget (solid line) compared with March 2019 forecasts (dotted line) as % GDP**
Source: OBR; CMMP analysis

A crucial week – part 1

On Wednesday 11 March 2020, the new UK Chancellor, Rishi Sunak announced the “largest sustained fiscal loosening since the pre-election Budget of March 1992” (OBR, 2020). Prior to the budget statement, the Bank of England also announced a package of measures – an unscheduled rate cut (to a historic low of 0.25%), the offer of cheap funding to banks, lowering banks’ capital buffers and expectations for banks to not increase dividends – in manner neatly described by the Chancellor as, “carefully designed to be complementary and to have maximum impact, consistent with our independent responsibilities.”

**Government spending (% GDP) rising to late 1970s levels – a major shift**
Source: OBR; CMMP analysis

Viewed through my preferred financial sector balances approach (summarised in Wynne Godley’s identity below), the new budget addresses last year’s (partially) flawed assumptions behind the policy of fiscal tightening ie, that a move towards a public sector surplus would be accompanied by a narrowing of the RoW’s net financial surplus and a widening of the private sector’s net financial deficit including higher level of borrowing. Instead it incorporates a widening in the net financial surplus of the household sector – appropriate given the high level of UK HH debt and low level of UK HH savings – offset by a widening in the public sector deficit. The assumptions regarding the balances of the NFC and RoW sectors remain largely unchanged.

Domestic private balance + domestic government balance + foreign balance = zero
Wynne Godley

On a positive note, this appears a more balanced policy including an appropriate shift in responsibility away from the HH sector to the UK government. The co-ordination between fiscal and monetary policy is also a positive sign. Nonetheless, the Government’s gross financing requirement averages around £150 billion a year over the next five years, around half as much again as a share of GDP as in the five years prior to the financial crisis. Hence, the OBR concludes that, “public finances are more vulnerable to adverse inflation and interest rate surprises than they were.” On top of this, the reliance on the RoW as a net lender to the UK economy remains an additional and obvious risk.

Attention now turns to the ECB. As noted in “Are we there yet?” the EA is positioned better to ease fiscal policy than the UK but immediate risks remain that policy response may be limited. Watch this space, we are half way though a crucial week for UK and European policy makers.

The charts that matter

Last year’s (partially flawed) assumptions

“We expect the public sector deficit to narrow slightly, offset by a small narrowing in the rest of the world surplus. The corporate and household sector deficits are expected to remain broadly stable. The general profile of sector net lending is little changed from previous forecasts, although the size of the household sector deficit is slightly smaller than in our October forecast, consistent with an upward revision to our forecast for household saving. The size of the rest of the world surplus is slightly larger, reflecting the upward revision to our forecast of the current account deficit.” (OBR, 2019)

New versus old – the HH sector

**HH sector is now expected to run wider net financial surpluses of between 1.3% and 1.6% of GDP**
Source: OBR; CMMP analysis

New versus old – the public sector (and the policy shift)

**The end of austerity and a shift to sustained fiscal loosening (public sector net financial deficit as % GDP)**
Souce: OBR; CMMP analysis

New versus old – little change to NFC sector forecasts

**NFC deficits are forecast to offset HH surpluses meaning that the private sector remains in deficit in aggregate (% GDP)**
Source: OBR; CMMP analysis

New versus old – still reliant on the RoW as a net lender

**“Still very dependent” – the OBR assumes that the RoW will continue to run net financial surpluses of c.4% GDP over the forecast period (% GDP)**
Source: OBR, CMMP analysis

March 2020 forecasts expressed through sector balances

**Widening HH surpluses offset by looser fiscal policy and widening NFC deficits (% GDP)**
Source: OBR; CMMP analysis

Conclusion

We are half way through a crucial week for UK and European policy makers. The first half saw a sustained loosening of fiscal policy by the new UK Chancellor, co-ordinated neatly with a package of measures from the Bank of England. This leaves a more balanced and appropriate policy mix.

In the second half, attention now focuses on the ECB and EA governments. The euro area is better placed than the UK to relax fiscal policy but the immediate risk remains that the policy response may be more limited. Watch this space.

Please note that the summary comments above are extracts from more detailed analysis that is available separately.

chris@cmmacroperspectives.com

“Brutally exposed”

First banks, now policy makers

The key chart – brutally exposed

**Sharp falls in large European banks’ share prices reflect dramatic weakening in macro foundations – “macro building blocks matter” (% change YTD to 9 March 2020, SX7E index heavyweights)**
Source: FT; CMMP analysis

A crucial week

This is a crucial week for European policy makers. The coronavirus has weakened the European banking sector’s macro foundations in a dramatic fashion and has exposed wider policy weaknesses. The SX7E index of European banks has fallen 32% YTD and underperformed the wider SXXE index by 16%. This performance is consistent with my CMMP narrative that (1) macro building blocks matter, and (2) that last year’s bounce was a relief rally rather than the start of a period of sustained recovery.

GDP growth expectations, that are stable and subdued at best, now face obvious downside risks, credit growth is showing early signs of peaking, ST and LT rates are at new lows and the yield curve is inverted. In this adverse environment for European banks, attention now switches to policy makers. They are equally exposed.

QE has already shifted the balance of power from lenders to borrowers and carries hidden risks in terms of future growth, leverage, financial stability and income inequality. In recent posts, I have argued that the EA remains trapped by its debt overhang and outdated policy rules, and that a major policy reboot is long overdue. It makes little sense for collective fiscal policy to be about as tight now as any period in the past twenty years at a time when the private sector is running persistent net financial surpluses.

The immediate risk is that this week’s policy responses remain limited. The ECB meets on Thursday with expectations of GDP downgrades, a cut in rates (to -0.6%), liquidity measures (and a possible adjustment to macroprudential tools) potentially discounted already. Far more helpful, indeed necessary, is clear co-ordination between political leaders and central bankers globally. A policy reboot would be a silver lining to the current storm gripping financial markets and global economies.

Watch this space, this is a crucial week.

The charts that matter

Mind the gap

SX7E “heavyweights” have fallen sharply from their 2020 highs – Soc Gen, Credit Agricole, Deutsche, ING, UCI, BNP Paribas are all more than 35% below peaks (% change from 2020 high to close on 9 March 2020)
Source: FT, CMMP analysis

MBB#1: Subdued GDP forecasts likely to be revised down

The ECB is likely to revise down its forecasts for GDP growth this week – current forecasts are based on global growth forecasts that have already been downgraded by the OECD, who have also downgraded EA GDP to 0.8% (2020e) and 1.2% (2021e)
Source: OECD; ECB; EC; Haver; CMMP analysis

MBB#2: Credit growth remains a “relative” bright spot

**HH (3.7% YoY) and NFC (3.2% YoY) credit growth is subdued in relation to past cycles but well above the levels associated with recession in the EA**
Source: ECB; Haver; CMMP analysis

MBB#3: ST rates locked at the base of the ECB corridor

A further cut in the deposit facility rate (t0 -0.6%) this week will be negative for NIMs in those countries (Austria, Italy, Portugal and Spain) and market segments (NFC lending) that are characterised by floating rate lending
Source: ECB; Haver; CMMP analysis

MBB#4: LT rates at new lows and firmly in negative territory

**10Y bond yields have returned to August 2019 lows of -0.71%**
Source: Haver; CMMP analysis

MBB#5: EA yield curve inverted again

The inversion of the yield curve has negative consequences for NIMs in countries (Belgium, France, Germany and the Netherlands) and market segments (HH lending) that are more exposed to fixed-rate lending
Source: Haver; CMMP analysis

Current policy has “hidden risks”

**QE risks fuelling the growth in less productive FIRE-based lending with negative implications for leverage, growth, stability and income inequality**
Source: ECB; Haver; CMMP analysis

Policy needs to match context #1 – a favourite graph again!

**The gap between the supply of money (M3) and the demand for credit has started to widen again, indicating an on-going deficiency in credit demand (and debt overhang)**
Source: ECB; Haver; CMMP analysis

Policy needs to match context #2 – what are balances saying?

**The private sector continues to run financial surpluses in spite of negative/low rates (4Q sums, % GDP)** **a clear message that the debt overhang remains**
Source: ECB; Haver; CMMP analysis

Finally, does this make sense?

**Does it make sense to run tight fiscal policy (1) at this point in the cycle, and (2) when the private sector is running persistent financial surpluses?**
Source: ECB; Haver; CMMP analysis

Conclusion

This remains a crucial week for European (and global) policy makers. The ECB is widely expected to downgrade its GDP growth forecasts and to cut the deposit facility rate to -0.6% (from -0.5%). Further liquidity support and adjustments to macroprudential tools are also probable. Unfortunately, this is unlikely to be sufficient to address market concerns, the impact of the debt overhang and slowing global growth. Far more hopeful, indeed necessary, is clear co-ordination between political leaders and central bankers globally. If there is to be a silver lining to the current storm, this would be it.

As noted in “Are we there yet?”, the EA is positioned better to ease fiscal policy than the UK (where both the private and public sectors are running simultaneous financial deficits) but we are more likely to see fiscal stimulus in tomorrow’s UK budget than in the former this week. Watch this space, this is a crucial week.

Please note that the summary comments above are extracts from more detailed analysis that is available separately.

chris@cmmacroperspectives.com