February 2021 – Chris Mallin Macro Perspectives

“Hawks vs Doves – part 1”

Look beyond the headines and a different story emerges

The key chart

**Growth in broad money (% YoY) since 1981** (Source: ECB; CMMP)

The key message

Inflation hawks in the euro area may cheer January’s record 12.5% YoY growth in broad money, but doves will take comfort from what is happening behind the headlines.

There is no sign of a moderation in household (HH) monthly deposit flows – January’s flows (€60bn) remain almost 2x the 2019 average and money sitting idly in savings accounts contributes to neither GDP nor inflation (n.b. growth in overnight deposits contributed 10.1ppt to overall money growth)
The gap between the money and credit cycle widened to a new high of 8.1ppt compared with 1.5ppt a year earlier. Credit demand remains subdued, despite the low cost of borrowing, while money supply accelerated. This is not a typical cycle
Finally, the region’s HHs have paid down consumer credit in four of the past five months. January’s -2.5% YoY change in consumer credit was the weakest level since February 2014

There is nothing in today’s data to change the pre-existing narrative. At the end of January, the score is 3:0 to the doves.

Three key charts for 2021 revisited

Inflation hawks in the euro area may cheer January’s record growth in broad money. M3 grew 12.5% YoY in January, from 12.4% in December 2020 and 11.0% in November 2020. This is the fastest rate of growth in the ECB’s current data series extending back to 1981 (see key chart above) and matches the previous peak level recorded in October and November 2007. Growth in narrow money (M1) also hit a new high (16.4% YoY) and contributed 11.3ppt to the total growth in M3. Within M1, overnight deposits grew 17.1% YoY and contributed 10.1ppt to the total growth in M3 alone. At this point, inflation hawks might begin to wonder…

Inflation doves, in contrast, will take comfort from what is happening behind the headlines. Earlier this month, I suggested that there were three key signals among the messages from the money sector to look for in 2021:

First, a moderation in monthly deposit flows
Second, a re-synching of money and credit cycles
Third, a recovery in consumer credit

Key signal #1

**Monthly flows of HH deposits as a multiple of the 2019 average monthly flow** (Source: ECB; CMMP)

Euro area HHs deposited €60bn in January, 1.8x the average 2019 monthly flow of €33bn. In the past three months, HH monthly flows have increased by €61bn (1.9x), €52bn (1.6x) and €60bn (1.8x) suggesting that HH uncertainty levels remain elevated. NFC monthly deposits of €22bn in January were also 1.7x their respective 2019 average. The key point here is that money sitting idly in savings accounts contributes to neither GDP nor inflation.

Key signal #2

**Growth (% YoY) in private sector credit minus growth in M3** (Source: ECB; CMMP)

The gap between the money and credit cycle widened even further in January. Private sector credit (a key counterpart to M3) grew by 4.4% YoY on an adjusted basis, down from 4.7% in December, and contributed only 5.4ppt to the growth in broad money (versus 5.7ppt in December). The difference between the growth in lending and the growth in money supply is now a new record of 8.1ppt. This compares with 1.5ppt a year earlier. Note that, in typical cycles, monetary aggregates and their counterparts move together. Money supply indicates how much money is available for use by the private sector. Private sector credit indicates how much the private sector is borrowing. The key point here is that credit demand remains relatively subdued, despite the low cost of borrowing, while money supply has accelerated. This is not a typical cycle.

Key signal #3

**Monthly consumer credit flows (EURbn) and growth rates (% YoY)** (Source: ECB; CMMP)

HHs repaid €2.5bn in consumer credit in January 2021 and the YoY growth rate fell to -2.5%, the weakest level since February 2014. Recall that consumer credit represents one section of COCO-based lending. It supports productive enterprise since it drives demand for goods and services, hence helping NFCs to generate sales, profits and wages. With HHs hoarding cash and lockdown measures remaining in place, weakness in consumer credit is not unexpected.

Conclusion

While inflation hawks may cheer accelerating growth in EA broad money, doves will correctly look beyond the headlines to note that HHs remain uncertain and continue to hoard cash, the gap between the money and credit cycle has widened even further and consumer credit trends remain weak. As yet, there is nothing in the messages from the money sector, to change the pre-existing narrative. At the end of January, the score is 3:0 to the doves.

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

“What if…”

…EA yield curves steepen but ST rates stay low?

The key chart

**10y-3m yield curves (7dMVA) in the US, Germany and France since 2018** (source: zeb; CMMP)

The key message

The gradual steepening of EA yield curves has led to renewed questions about the relative importance of the shape of the yield curve vis-à-vis the level of ST rates for the region’s banks (and their share price performance).

Banks’ NIMs have a positive relationship with both factors but, generally, the former is more important in countries and sectors exposed to higher fixed-rate lending and vice versa. Despite a shift away from floating-rate lending since 2009, just under 60% of all new loans to HHs and NFCs in the EA carry a floating rate. In other words, sensitivity to the level of ST rates remains high. As always, however, significant variations exist at the country, sector (and individual bank) levels. In France and the Netherlands, for example, only 36% of new loans carry a floating rate and only 15% of new mortgage loans for the entire EA carry a floating rate.

A scenario of steeper yield curves combined with delayed ST rate rises is broadly positive for the sector, and would favour fixed-rate countries (France, Netherlands, Belgium) and fixed-rate mortgage lending markets (France, Belgium, Germany, Netherlands, Italy, Ireland, Spain, Austria). This is very different from the (short-lived) period in early 2018 when expectations focused on higher ST rates combined with flatter yield curves. This favoured floating-rate economies (Finland, Portugal, Italy, Austria and Spain), NFC-lending sectors and floating-rate mortgage markets (Finland, Portugal) and led to brief outperformance from Italian, Spanish banks (and Erste Bank).

Investors’ expectations were dashed ultimately in 2018 and the case for a sustained steepening in EA yield cases remains unproven today (especially given M Lagarde’s comments on 22 February that the ECB was “closely monitoring” the market for government bonds).

On Thursday this week (25 February), the ECB will release its first review of monetary developments in the EA for 2021. As noted in my previous post, the key signals to look for then and in subsequent 2021 releases are: a moderation in monthly deposit flows; a resynching of money and credit cycles; and a recovery in consumer credit.

“What if?” – The charts that matter

**Trends in German and French 10y-3m yield curves (7d MVA) over past 6 months** (Source: zeb; CMMP)

Yield curves in the euro area’s (EA) two largest economies have steepened YTD (see chart above) albeit to a lesser extent than in the US (see key chart). This leads to the obvious question about the relative importance of the shape of the yield curve vis-à-vis the level of ST rates for the region’s banks (and their share price performance).

Yield curves versus ST rates – the background

Banks’ net interest margins (NIMs) have a positive relationship with both the shape of the yield curve and the level of ST rates. In short, this reflects two core functions of services that banks provide – a maturity transformation service (yield curve) and a deposit transaction service (ST rates). The relative importance of each factor depends largely on whether lending is predominantly fixed or floating-rate lending.

The slope of the yield curve is more relevant in countries or sectors with relatively high exposure to fixed-rate lending. In contrast, changes in ST rates have a greater impact on net interest margins in countries or sectors that are characterised by floating-rate lending. Furthermore, banks prefer a fixed rate when they expect reference rates to decline in the future and prefer a variable rate when they expect reference rates to increase. Borrowers have opposite preferences. In this regard, differences between loan characteristics provide an indication about the expectations of banks and borrowers with respect to the evolution of rates and their respective bargaining power. This in turn depends on factors such as banks’ funding conditions, competitive dynamics and borrowers’ levels of solvency.

(The impact of bank size is acknowledged here but is beyond the scope of this summary. However, it is worth noting that bank size may also have an impact on the sensitivity to both factors. This reflects the fact that larger banks are typically able to hedge their interest rate risk exposures better than smaller banks.)

Yield curves versus ST rates – the EA context

**Share of new loans to HH and NFC with a floating rate** (Source: ECB; CMMP)

Despite a shift away from floating-rate lending since 2009, 59% of all new loans to HHs and NFCs in the EA carry a floating rate (or an initial fixation period of up to one year). The peak level of floating rate lending in the past 15 years occurred after the GFC in January 2009 (84%). The lowest level occurred very recently in November 2020 (55%). As explained below, this trend affects both country and sector effects.

The key point here is that, while the sensitivity to the shape of the yield curve has increased, EA banks remain highly sensitive to the level of ST rates (at the aggregate level).

**Share of new loans to HH and NFC with a floating rate by country, December 2020** (Source: ECB; CMMP)

As always, however, significant variations exist at the country, sector (and individual bank) levels. The highest shares of floating-rate lending in new loans are currently found in Finland (93%), Portugal (78%), Italy (73%), Austria (68%), Spain (68%) and Ireland (66%). In contrast floating-rate lending in the Netherlands and France accounts for only 37% and 36% of total new loans respectively (see chart above).

**Share of new mortgage loans with a floating rate** (Source: ECB; CMMP)

While NFC lending remains largely floating-rate, only 15% of new mortages carry a floating rate (see chart above). Again significant differences exist here at the country level. The share of floating rate mortgages in total new mortgages ranges from highs of 98% and 67% in Finland and Portugal respectively to lows of 10%, 4% and 2% in Germany, Belgium and France respectively (see chart below).

**Share of new mortgage loans with a floating rate by country, December 2020** (Source: ECB; CMMP)

Yield curves versus ST rates – different scenarios

This is very different from the (short-lived) period in early 2018 when expectations focused on a scenario of higher ST rates combined with flatter yield curves. This favoured floating-rate economies (Finland, Portugal, Italy, Austria and Spain), NFC-lending sectors and floating-rate mortgage markets (Finland, Portugal) and led to ST outperformance from Italian, Spanish banks (and Erste Bank).

Conclusion

Investors’ expectations were dashed ultimately in 2018 and the case for a sustained steepening in EA yield cases remains unproven today, especially given M Lagarde’s comments on 22 February that the ECB was “closely monitoring” the market for government bonds. This was interpreted as a sign that the ECB might act to prevent rising yields undermining any economic recovery.

On Thursday this week (25 February), the ECB will release its first review of monetary developments in the EA for 2021. As noted in my previous post, the key signals to look for then and in subsequent releases are: a moderation in monthly deposit flows; a resynching of money and credit cycles; and a recovery in consumer credit (see, “Three key charts for 2021”)

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

“Three key charts for 2021”

And the trends that investors SHOULD be looking for…

The key chart

**Growth rates (% YoY) in UK and EA broad money aggregates** (Source: BoE; ECB; CMMP)

The key message

Should investors positioned for an upturn in inflation and sustained outperformance from cyclical and value plays and/or shorter duration trades be hoping for stronger or weaker money supply growth in the UK and EA in 2021?

Contrary to the popular narrative, the answer is likely to be the latter not the former. In this post, I summarise why this is the case and highlight the three key charts to follow in 2021.

Over the past decade, we have witnessed a sustained shift in the components of broad money supply (M3) with greater contribution coming from holdings of the most liquid assets ie, narrow money (M1). The reaction of UK and EA households to the COVID-19 pandemic has accelerated this trend, as levels of forced and precautionary savings have risen sharply, particularly in the UK.

The challenge for inflation hawks here is that money sitting idly in savings accounts contributes to neither GDP nor inflation.

Analysis of the counterparts of monetary aggregate highlights the extent to which money and credit cycles are diverging in both regions. Within subdued overall levels of private sector credit demand, relatively robust NFC credit and resilient mortgage demand offset weakness in consumer credit during 2020. Weakness in consumer credit was more noticeable in the UK, where net repayments of £17bn made 2020 the weakest year for consumer credit on record.

There are three key signals among the messages from the money sector in 2021 to look for:

First, a moderation in monthly deposit flows
Second, a re-synching of money and credit cycles
Third, a recovery in consumer credit.

Trends in 2020, suggest that the UK has a relatively high gearing to each of these trends.

The charts that mattered in 2020

**Share of narrow money in UK and EA broad money since 2010** (Source: ECB; BoE; CMMP)

Over the past decade, we have witnessed a sustained shift in the components of broad money supply (M3) with greater contribution coming from holdings of the most liquid assets ie, narrow money (M1). At the end of 2010, M1 accounted for 46% and 51% of M3 in the UK and EA respectively. By the end of 2020, these shares had risen to 67% and 71% respectively (see chart above).

In other words, changes in holdings of notes and coins and overnight deposits are having a greater impact on the behaviour of money supply. As noted in, “The yawning gap”, for example, M1 contributed 10.7ppt to the 12.3% growth in EA M3 in 2020.

**Monthly flows of HH money in the UK** (Source: BoE; CMMP)

The reaction of UK and EA households to the COVID-19 pandemic has accelerated this trend, as levels of forced and precautionary savings have risen sharply.

The first COVID-related death in the UK was recorded on 5 March 2020 and the first lockdown began 18 days later on the 23 March 2020. UK households increased their money holdings by £14bn, £17bn and £27bn in March, April and May 2020 respectively. This £58bn increase in holdings was greater than the total flow of £55bn recorded in 2019. Households began to increase then money holdings sharply again in October 2020, even though the second lockdown did not come into effect until 5 November 2020. In the last three months, UK households increases their money holdings by £13bn, £18bn and £21bn (£52bn in total), 3-4x the average monthly flows in 2019 (see chart above).

**Monthly flows of HH deposits in the EA** (Source: ECB; CMMP)

Similar household behaviour was seen in the euro area albeit with slightly different timings and scale. In the early stage of the pandemic, household deposits increased by €78bn and €75bn in March and April 2020 respectively, more than double the average 2019 monthly flows. In November and December 2020, monthly flows increased again to €61bn and €53bn (see chart above).

The challenge for inflation hawks here is that money sitting idly in savings accounts contributes to neither GDP nor inflation.

**Growth in private sector credit minus growth in money supply in the UK and EA** (Source: BoE; ECB; CMMP)

Analysis of the counterparts of monetary aggregate highlights the extent to which money and credit cycles are diverging in both regions. As noted last month, in typical cycles, monetary aggregates and their key counterparts move together. Money supply indicates how much money is available for use by the private sector. Private sector credit indicates how much the private sector is borrowing.

At the end of 2019, the gap between the growth in lending and the growth in money supply was 0.6ppt and -2ppt in the UK and EA respectively. By the end of 2020, these gaps had widened to record levels of -9.9pt and -7.6ppt (see chart above). Simply put, credit demand has remained relatively subdued in both regions, despite the low cost of borrowing, while money supply has accelerated.

**Trends in NFC credit, mortgages and consumer credit since 2018** (Source: BoE; ECB; CMMP)

Within subdued overall levels of private sector credit demand, relatively robust NFC credit and resilient mortgage demand offset weakness in consumer credit during 2020 in both regions (see chart above). The YoY growth in NFC credit in the UK increased from 3.3% in 2019 to 7.7% in 2020. Similarly, the respective growth rates in the EA increased from 3.2% in 2019 to 7.0% in 2020. Mortgage growth in the UK moderated slightly from 3.4% in 2019 to 3.0% in 2020 but rose from 3.9% in 2019 to 4.7% in 2020 in the EA. Consumer credit grew 6.1% and 6.0% in the UK and EA in 2019 respectively, but fell 7.5% and 1.6% in 2020 respectively.

**2020 monthly trends in HH consumer credit in the UK** (Source: BoE; CMMP)

**2020 monthly trends in HH consumer credit in the EA** (Source: ECB; CMMP)

The weakness in consumer credit was more significant in the UK than in the EA. Net repayments of £17bn made 2020 the weakest year for consumer credit on record. UK households repaid consumer credit in the last four months of 2020 and the annual growth rate of minus 7.5% represented the weakest rate of growth since the series began in 1994 (see first of the charts above). EA households also repaid consumer credit in three of the last four months of 2020, but the YoY decline of minus 1.6% was more moderate than in the UK.

Conclusion and three charts to watch in 2021

A sustained upturn in inflation and outperformance from cyclical and value sectors and shorter duration trades will require confidence, consumption and investment to return fully. There are three key signals to look for in the messages from the UK and EA money sectors in 2021.

**Monthly deposit flows as a multiple of the 2019 monthly average** (Source: BoE; ECB; CMMP)

First a moderation in monthly deposit flows, especially by the household sector, and slower growth in narrow money (M1) and hence broad money (M3).

**The yawing gap between money supply and private sector credit demand** (Source: BoE; ECB; CMMP)

Second, a re-synching of money and credit cycles with a corresponding rebalancing in the counterparts of broad money growth.

**Trends in YoY growth rates for UK and EA consumer credit** (Source: BoE; ECB; CMMP)

Third, and finally, a recovery in consumer credit. Consumer credit represents one section of COCO-based lending (see “Fuelling the FIRE”). Its supports productive enterprises since it drives demand for goods and services, hence helping NFCs to generate sales, profits and wages.

The relative scale in the shift of money holdings and weakness in consumer credit suggests that the UK has a higher gearing than the EA to a reversal of 2020’s COVID-19 induced dynamics. Watch this space in 2021…

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

“Bouncing back”

Relative cheer from UK mortgages

The key chart

**Positive volume trends (outstanding balances, monthly flows, YoY growth) for UK mortages in 4Q2020** (Source: BoE; CMMP)

The key message

UK mortgages provide some relative cheer among otherwise downbeat messages from the money sector:

Individuals borrowed £5.6bn in the form of mortgages in December 2020, unchanged from November, while repaying £1.0bn in consumer credit.
Quarterly flows (£15.9bn) in 4Q2020 were the highest since 1Q2008.
Despite this strong recovery, mortgage borrowing in 2020 (£43.3bn) was lower than in 2019 (£48.1bn) and current demand remains subdued in relation to previous cycles.
Looking forward, mortgage approvals (103,400) were the second highest since August 2007, and suggest positive future volume trends.
The effective interest rate on new mortgages rose 7bp in December to 1.9%, the highest rate since October and the spread between this and the rate on the outstanding stock narrowed to 22bp, from 55bp in February 2020.

Among mortgage providers, the sector winners are not simply riding these trends but are also increasingly embracing digitalisation across operations, sales, finance and risk management to differentiate themselves and improve the experience for their members.

The six charts that matter

**Monthly flows in UK retail lending (£bn) for 2020** (Source: BoE; CMMP)

The UK mortgage market continues to provide some relative cheer among otherwise downbeat messages from the money sector (see chart above). Individuals borrowed an additional £5.6bn in the form of mortgages in December 2020, broadly unchanged from November. In contrast, households repaid £1.0bn in consumer credit, having repaid £1.5bn, £0.6bn and £0.8bn in the three preceding months.

**UK mortgage volumes “bounced back” strongly from 2Q low** (Source: BoE; CMMP)

Quarterly mortgage flows totalled £15.9bn in 4Q20 compared with £11.1b, £3.8bn and £12.5bn in the three preceding quarters respectively. As can be seen in the chart above, this was the largest quarterly flow in the past five years and the largest since 1Q2008.

**But real growth remains subdued in relation to past cycles** (Source: BoE; CMMP)

Despite this strong recovery, however, total 2020 mortgage borrowing of £43.3bn was below 2019’s total of £48.1bn. Current mortgage demand also remains subdued in relation to past cycles (see chart above). In real terms, the 3-month MVA for mortgage demand was only 2.3% in December 2020, essentially stable real growth over the 2H2020

**Trends in approvals for house purchases** (Source: BoE; CMMP)

.Looking forward and more positively, mortgage approvals, which have proved a reliable indicator of future lending, were 103,400 in December, the second highest level since August 2007 (see chart above), and totalled 818,500 in 2020, the largest yearly number since 2007.

Effective interest rates on new mortgages and on the outstanding stock (Source: BoE; CMMP)

The effective interest rate on new mortgages rose 7bp in December to 1.9%, the highest rate since October 2019 (see chart above). This rate remains below the rate on the outstanding stock of mortgages (2.12%) but the spread between the two effective rates has narrowed to 22bp from 55bp in February 2020 (see chart below).

**Downward pressure on NIMs starting to ease?** (Source: BoE; CMMP)

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