Recovery and reflation trades require more substantial foundations
The key chart
Growth in M3 (% YoY) and contributions (ppt) from M1 and PSC (Source: ECB; CMMP)
The key message
It is tough to get too excited about the messages coming from the euro area’s (EA) money sector at the start of 3Q21.
Broad money growth is almost 5ppt lower than its January 2021 peak. The positive news here is that households are saving less, indicating that uncertainty levels have fallen. The less positive news is that growth in private sector credit has also fallen to its slowest rate since December 2017. Total lending is growing only 0.8% YoY in real terms and is falling -1.3% YoY in real terms if we exclude lending to HH (mainly mortgages).
In short, while the message from the money sector remains positive for (already overvalued) house prices in the euro area, the wider message is that both a sustained recovery and reflation trades require a more substantial foundation.
The six charts that matter
Growth in EA broad money % YoY (Source: ECB; CMMP)
It is tough to get too excited about the messages coming from the euro area (EA) money sector at the start of 3Q21. Growth in broad money (M3) slowed to 7.6% YoY in July 2021, almost 5ppt below the January 2021 recent high of 12.5% (see chart above). The positive news is that this reflects a reduction in the deflationary forces that drove M3 growth during the pandemic.
YoY growth rates in M3 and M1 since 2001 (Source: ECB; CMMP)
Narrow money (M1) which contributed 7.7ppt to the total 7.6% YoY M3 growth has slowed from 16.5% in January 2021 to 11.0% in July 2021 (see chart above). In short, EA households are saving less.
Monthly flows (EUR bn) of HH deposits during phases of pandemic (Source: ECB; CMMP)
Overnight deposits still account for 6.8ppt of total M3 growth, but in aggregate household monthly deposit flows fell to €23bn in July 2021, below the 2019 average monthly flow of €33bn and the smallest monthly flow since June 2019 (see chart above).
Growth in PSC (% YoY 3m MVA) since 2001 (Source: ECB; CMMP)
The less positive news is that credit demand is also slowing. Private sector credit contributed only 3.5ppt to M3 growth and the YoY growth rate slowed to 2.9% YoY (3MVA) the slowest growth since December 2017 (see chart above).
Trends in growth in lending and contribution from lending x HH (Source: ECB; CMMP)
As noted in “Strip out HH lending”, current lending is predominantly less-productive FIRE-based lending rather than productive COCO-based lending. Total lending grew 0.8% YoY in real terms in July, but fell -1.3% YoY in real terms excluding HH lending (see chart above). HH lending contributed 2.2ppt to the total 3.1% nominal growth in lending in July 2021 (see chart below).
Drivers of PSC growth (Source: ECB; CMMP)
Conclusion
In summary, while the message from the money sector remains positive for (already overvalued) house prices in the euro area, the wider message is that both a sustained recovery and reflation trades require a more substantial foundation.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
…and PSC growth is falling in real terms in the EA
The key chart
Real YoY growth rates in total lending and total minus HH lending (Source: ECB; CMMP)
The key message
Strip out lending to households (mainly mortgages) and private sector lending in the euro area (EA) is falling in real terms. Why does this matter?
A resynchronisation of money and credit cycles in the euro area is one of three key signals indicating a sustained economic recovery for investors and policy makers alike. The ideal scenario would see a reduction in the deflationary forces that drove M3 growth during the pandemic (i.e. HH money holdings) combined with a recovery in productive lending to the private sector. To date, we have witnessed progress in the former but not in the latter.
Monthly flows of HH deposits in April, May and June 2021 were below pre-pandemic levels, for example. Lending to the private sector is slowing too, however, from 4.7% at end 2020 to 3.0% at the end of 1H21. Base effects play a role here as EA corporates borrowed €243bn in the immediate “dash for cash” in March, April and May 2020. For context, net borrowing over the subsequent 12 months to June 2021 totalled only €103bn.
Significantly, total lending minus HH lending (predominantly productive COCO-based lending) contributed only 0.8ppt to the 3.0% YoY lending growth in June 2021. In contrast, HH lending contributed 2.1ppt, the bulk of which is in the form or mortgages.
In other words, current lending is essentially less-productive FIRE-based lending rather than productive COCO-based lending. While this may provide further support for house prices, a sustained recovery requires a more substantial foundation.
The six charts that matter
Growth (% YoY) in broad money and private sector credit (Source: ECB; CMMP)
A resynchronisation of money and credit cycles in the euro area is one of three key signals indicating a sustained economic recovery for investors and policy makers alike.
What drove M3 growth during the pandemic? (Source: ECB; CMMP)
The ideal scenario would see a reduction in the deflationary forces that drove M3 growth during the pandemic (i.e. HH money holdings) combined with a recovery in productive lending to the private sector. To date, we have witnessed progress in the former but not the latter.
Monthly flows (EUR bn) in HH deposits (Source: ECB; CMMP)
To date, we have the former but not the latter. Monthly flows of household deposits in April, May and June 2021 were below pre-pandemic levels. So far, so good.
Nominal YoY growth rates in total lending and total minus HH lending (Source: ECB; CMMP)
Lending to the private sector is slowing too, however, from 4.7% at end 2020 to 3.0% at the end of 1H21.
Monthly flows in NFC borrowing in EUR bn (Source ECB; CMMP)
Base effects play a part here as EA corporates borrowed €243bn in the immediate “dash for cash” in March, April and May 2020. For context, net borrowing over the subsequent 12 month to June 2021 totalled only €103bn.
Drivers of PSC growth by type (Source: ECB; CMMP)
Significantly, total lending minus HH lending (predominantly productive COCO-based lending) contributed only 0.8ppt to the 3.0% YoY lending growth in June 2021. In contrast, HH lending contributed 2.1ppt, the bulk of which is in the form or mortgages.
In other words, current lending is essentially less-productive FIRE-based lending rather than productive COCO-based lending. While this may provide further support for house prices, a sustained recovery requires a more substantial foundation.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Monthly mortgage flows since January 2019 (Source: ECB; CMMP)
The key message
Monthly mortgage flows suggest that Spain is re-joining the “euro area mortgage party” but this presents mixed messages for investors.
Spain remains the euro area’s (EA) third largest mortgage market despite the fact that the outstanding stock of mortgages (€510bn) is 23% below its December 2010 peak (€665bn). Spain’s market share has fallen from 19% of EA mortgages in December 2008 to 11% in June 2021 and Spanish MFIs have recorded 120 consecutive months of negative contributions to EA mortgage growth since April 2011.
Monthly mortgage flows turned positive in February 2021, however. Annual growth rates turned positive in May 2021 and Spanish MFIs made a positive, albeit small, contribution to total EA growth in June 2021. I highlighted four factors that suggested a more positive demand-side outlook two months ago (see “More consistent than Rapha”). First, the HH debt ratio has fallen back in line with EA averages following a decade of deleveraging. Second, the cost of borrowing is at a record low. Third, the HH debt service ratio is below the LT average and close to its 20-year low. Finally, Spanish house prices are 28% below their peak in real terms with less extreme valuations than elsewhere in the EA.
The latest dynamics present mixed messages for investors. On the bright side, a sustained positive contribution to EA growth represents an important signal for investors positioned for a wider recovery in Europe. Germany and France have been the main drivers of mortgage growth in the recent past, but demand is now widening with Belgium, the Netherlands, Italy, Austria and Spain making larger collective contributions.
That said, these trends also reflect the broader substitution of productive COCO-based lending with less-productive FIRE-based lending in the euro area, which has negative implications for leverage, growth, financial stability and income inequality in the region. Spain has seen the largest shift in percentage points from COCO-based to FIRE-based lending since January 2009 but uniquely this reflects falls in the outstanding stock of both COCO-based (-€488bn) and FIRE-based lending (-€125bn) over the period.
The underlying message here is that mortgage dynamics in the periphery of the EA remain very different from those in the core re-enforcing the message that a “one-size-fits-all” policy response will not suffice.
“Bienvenido de nuevo” in charts
Market share of EA total mortgages (Source: ECB; CMMP)Outstanding stock of Spanish mortgages and market share (Source: ECB; CMMP)Spanish MFIs contribution to EA mortgage growth (Source: ECB; CMMP)Country drivers of EA mortgage growth (Source: ECB; CMMP)Trends in balance between COCO-based and FIRE-based lending (Source: ECB; CMMP)Spanish COCO-based lending (Source: ECB; CMMP)Spanish FIRE-based lending (Source: ECB; CMMP)
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Expect a steady release of the £150bn of excess savings
The key chart
Aggregate card payments versus pre-COVID levels (Source: ONS; CMMP)
The key message
UK GDP grew 4.8% YoY in 2Q21 as consumer spending rebounded following the easing of COVID-19 restrictions during the quarter. The message from the money sector, which has foreshadowed official data well, remains positive but with the risk of momentum slowing. The £150bn of “excess savings” are likely to return to consumption in a steady rather than dramatic fashion.
Spending on credit and debit cards, which has been rising since early January, accelerated further with the re-opening of non-essential retail stores on 12 April 2021. In relation to pre-COVID levels, the largest increases in spending since the latest relaxation have been on the “work-related” (31ppt) and “delayable” (30ppt) goods. In contrast, spending on “staples” has slowed (but remains above pre-COVID levels).
Spending has increased further so far in the 3Q21: social (11ppt); work-related (6ppt); delayable (2ppt) and staples (1ppt). However, it is below recent peaks in each category and below (delayable, social) or at (aggregate) pre-COVID levels.
Separately, the money sector is indicating that household uncertainty remains elevated as indicated by monthly flows of money holdings that remain 2x pre-COVID levels. On a positive note, this suggests that excess savings built up during the pandemic now exceed £150bn.
Spending on delayables is the best indicator of the extent to which excess savings are returning to the economy via sustained consumption. The evidence to date is that this is happening in a steady rather than dramatic fashion.
Where next – in charts
Change in card spending (ppt) since 12 April relaxation versus pre-COVID levels (Source: ONS; CMMP)Spending trends so far in 3Q21 (to 5 August) versus pre-COVID levels (Source: ONS; CMMP)Monthly flows (£bn) of HH money holdings since January 2009 (Source: BoE; CMMP)CMMP estimates of build up of excess savings during the pandemic (Source: BoE, CMMP)Trends on aggregate spending and spending on delayable goods versus pre-COVID levels (Source: ONS; CMMP)
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Change in the stock of COCO-based lending Jan 2009 – June 2021 in EUR bn (Source: ECB; CMMP)
The key message
Policy makers face significant challenges in addressing the implications of rising FIRE-based lending in the euro area.
My previous post highlighted the on-going substitution of productive COCO-based lending for less productive FIRE-based lending in the euro area (EA), noted the lack of COCO-based lending at the aggregate level since January 2009, and examined the implications for leverage, growth, financial stability and income inequality.
This post looks behind the aggregate headlines and focuses on three key differences at the country and regional level:
First, the share of FIRE-based lending among the EA’s six largest economies/banking markets at the end of 1H21 ranges widely from 65% in the Netherlands to 43% in Italy
Second, while the share of FIRE-based lending has increased in each economy, the drivers have been very different
Third, the lack of growth in COCO-based lending masks divergent trends between periphery economies (falling stock in Spain and Italy) and core economies (rising stock elsewhere)
Behind each of these differences lie significant variations in the level, structure and growth of debt across the euro area e.g. the Netherlands versus France, Belgium, Spain versus Germany and Italy.
In addressing the negative implications of rising FIRE-based lending in the EA, policy makers must address significant variations that exist at the regional and country level. A “one-size-fits-all” response will not suffice.
FIRE, FIRE II – three key differences, six key charts
Balance of lending – FIRE vs COCO
FIRE-based versus COCO-based lending as at end 1H21 (Source: ECB; CMMP)
The balance between FIRE-based and COCO-based lending varies widely across the EA. Among the six largest banking sectors that account for c.90% of total credit, FIRE-based lending ranges from 65% of total private sector credit in the Netherlands to 43% in Italy (see chart above). Across the 19 EA economies, the low end of this range extends down to 39% in Greece and 41% in Slovakia while Ireland (61%) joins the Netherland and Belgium with a relatively high share of FIRE-based lending.
In the Netherlands and Belgium, the two economies with the highest share of FIRE-based lending, the NFC debt ratios of 152% and 166% GDP respectively are well above the BIS threshold of 90%. In both cases, the NFC sectors have been deleveraging with debt ratios falling from peaks of 180% GDP in the Netherlands (1Q15) and 171% GDP in Belgium (2Q16). The HH sector dynamics are very different however, re-enforcing the message that the EA money sectors are far from a homogenous group (see below). In the Netherlands, the HH sector has also been deleveraging since 3Q10 when the debt ratio hit 121% GDP. At the end of 1H21, the ratio had fallen to 105% GDP. In contrast, HH leverage is increasing in Belgium with the debt ratio hitting a new high (albeit a relatively low one) of 66% GDP in 2Q21.
Drivers of change in lending balance
Change in share of FIRE-based lending and share of total lending as at end 1H21 (Source: ECB; CMMP)
While the share of FIRE-based lending has increased in each economy since January 2009 (see chart above), the drivers have been very different (see chart below). Spain saw the largest change in percentage points (11ppt) as the fall in the outstanding stock of COCO-based loans (-€488bn) was greater than the fall in the stock of FIRE-based loans (-€125bn). Italy saw the second largest change (10ppt) driven by a fall in the stock of COCO-based loans (-€153bn) and a rise in the stock of FIRE-based loans (€125bn). In contrast, France’s 6ppt increase from 46% to 52% loans reflected the largest absolute increases in both FIRE-based (€715bn) and COCO-based lending (€715bn).
Changes in COCO- and FIRE-based loans since January 2009 by country (Source: ECB; CMMP)
Core versus periphery
Core vs Periphery – change in COCO-based lending since January 2009 (Source: ECB; CMMP)
The lack of growth in COCO-based lending at the aggregate level masks divergent trends at the regional level between periphery economies (falling stock) and core economies (rising stock). The stock of COCO-based loans fell -€79bn in aggregate between January 2009 and June 2021 (NFC-€130bn, consumer credit +€51bn). In the core economies of Germany and France, the stock of COCO-based loans rose by €674bn (€241bn in Germany, €433bn in France). In the periphery economies of Spain and Italy, however, the stock fell by -€641bn (-€488bn in Spain, -€153bn in Italy).
Core vs Periphery – change in FIRE-based lending since January 2009 (Source: ECB; CMMP)
Similarly, the stock of FIRE-based lending rose €1,349bn between January 2009 and June 2021. In Germany and France the stock of FIRE-based loans increased €1,224bn (€509bn in Germany, €715bn in France). In Spain and Italy there was no growth as the -€125bn decline in Spanish FIRE-based loans counterbalanced the €125bn increase in Italian FIRE-based loans.
Background debt dynamics
NFC debt ratios (x-axis) versus HH debt ratios (y-axis) and BIS threshold levels (Source: BIS; CMMP)
Behind each of these differences lies significant variations in the level, structure and growth of debt across the euro area that complicate required policy response further. The chart above plots the EA and the six largest markets in terms of NFC and HH debt ratios versus the maximum threshold limits identified by the BIS as the level above which debt becomes detrimental to future growth.
At the aggregate level, the EA is characterised by excess NFC debt ratios (115% GDP versus 90% GDP threshold level). The HH debt ratio of 63% GDP remains below the 85% GDP HH threshold level. The Netherlands is unique here in the sense that both NFC and HH debt ratios are above the respective thresholds. France, Belgium and Spain all have excess NFC debt ratios but very different NFC debt dynamics (rising rapidly in France and Belgium while falling in Spain). In contrast, Germany and Italy have neither excess HH nor excess NFC debt ratios.
Conclusion
The on-going substitution of productive COCO-based lending for less productive FIRE-based lending has negative implications for leverage, growth, financial stability and income inequality in the EA. A policy response is required. Aggregate trends mask significant differences at the country and regional level, however, which complicate policy choices. A “one-size-fits-all” response will not suffice.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Outstanding stock of COCO-based loans since 2003 in EURbn (Source: ECB, CMMP)
The key message
Bank lending to the private sector falls into two distinct types: (1) lending to support productive enterprise (“COCO-based”); and (2) lending to finance the sale and purchase of exiting assets (“FIRE-based”). While the stock of total loans to the euro area (EA) private sector hit a new high at the end of 1H21, the stock of productive COCO-based lending remains below its January 2009 peak. In other words, the (aggregate) growth in lending since January 2009 has come exclusively from FIRE-based lending. This accounts for 52% of all outstanding loans now versus 45% in January 2009.
This shift matters because while COCO-based lending supports both production AND income formation, FIRE-based lending supports capital gains through higher asset prices but does not lead directly to income generation. Neither QE nor COVID-19 caused this shift but both added momentum to it. This trend provides support for Minsky’s hypothesis that, over the course of a long financial cycle, there will be a shift towards riskier and more speculative sectors. The implications extend well beyond the over-valuation of residential property prices. Current dynamics, fuelled in part by current policy, have wider, negative implications for leverage, growth, financial stability and income inequality. Time for another policy reboot?
FIRE, FIRE – what has happened?
Outstanding stock of total loans (EURmn) split between the two forms of lending (Source: ECB, CMMP)
Bank lending to the private sector falls into two distinct types: (1) lending the support productive enterprise; and (2) lending to finance the sale and purchase of exiting assets (see chart above). The former includes lending to corporates (NFCs) and household (HH) consumer credit. Such loans are referred to collectively as “COCO-based” loans (COrporate and COnsumer). The latter includes loans to non-bank financial institutions (NBFIs) and HH mortgage or real estate. These loans are referred to collective as “FIRE-based” loans (FInancials and Real Estate).
Change in stock of loans (EURbn) by type since January 2009 (Source: ECB; CMMP)
While the stock of total loans to the euro area (EA) private sector hit a new high at the end of 1H21, the stock of COCO-based lending remains below its January 2009. Total PSC rose €1,200bn over the period to €12,071bn (see chart above). Total COCO-based loans fell -€79bn (NFC -€130bn, consumer credit €51bn). Total FIRE-based loans, in contrast, rose €1,349bn (mortgages €1,356bn, financial institutions -€55bn; insurance companies and pension funds €48bn).
Trends in stock of FIRE-based lending (EURbn) and market share of total PSC (Source: ECB; CMMP)
In other words, (aggregate) growth in lending since January 2009 has come exclusively from FIRE-based lending. In June 2021, FIRE-based lending hit a new high of €5,937bn. This is 29% higher than the January 2009 level. Its market share has increased from 45% to 52% over the period.
FIRE, FIRE – why this matters
This matters because COCO-based lending supports both production and income formation. Loans to NFCs are used to finance production, which leads to sales revenues, wages paid, profits realised and economic expansions. So while an increase in NFC debt will increase debt in the economy, it also increases the income required to finance it. Consumer debt also supports productive enterprise since it drives demand for goods and services, helping NFCs to generate sales, profits and wages, It differs from NFC debt to the extent that HHs take on an additional liability since the debt does not generate income.
In contrast, FIRE-based lending supports capital gains through higher asset process but does not lead directly to income generation. Loans to NBFIs are used primarily to finance transactions in financial assets rather than to produce, sell or buy actual output. Such credit may lead to an increase in the price of financial assets but does not lead (directly) to income generation. Mortgage or real estate lending is used to finance transactions in pre-existing assets. It typically generates asset gains as opposed to income (at least directly).
Wider implications
Growth rate (% YoY) in EA house prices (Source: Eurostat; CMMP)
Much recent attention has focused on the impact of the COVID-19 and unorthodox monetary policy on residential property prices (see “Herd immunity”). This analysis shows that the shift towards FIRE-based lending pre-dates both, however, and has much wider and negative implications for leverage, growth, financial stability and income inequality in the EA:
Leverage: while COCO-based lending increases absolute debt levels, it also increases incomes (albeit with a lag). Hence, overall debt levels need not rise as a consequence. In contrast, FIRE-based lending increases debt and may increase asset prices but does not increase the purchasing power of the economy as a while. Hence, it is likely to result in higher levels of leverage.
Growth: COCO-based lending supports growth both by increasing the value-add from final goods and services (“output”) and an increase in profits and wages (“income”). FIRE-based lending typically only affects GDP growth indirectly.
Financial stability: the returns from FIRE-based lending (investment returns, property prices etc) are typically more volatile than returns from COCO-bases lending and may affect the solvency of lenders and borrowers. In the May 2021, Financial Stability Review, the ECB noted that, “a combination of buoyant house price growth and the uncertain macro backdrop kept measures of overvaluation elevated.” Moreover, house price growth during the pandemic has generally been higher for those countries that were already experiencing pronounced overvaluation prior to the pandemic.”
Inequality: the returns from FIRE-based lending are typically concentrated in higher-income segments of the populations, with any subsequent wealth effects increasing income inequality.
Stock and market share of COCO- and FIRE-based lending (Source: ECB; CMMP)
Conclusion
Neither QE nor COVID-19 caused the shift away from productive COCO-based lending towards FIRE-based lending. Both did, however, add momentum to a pre-existing trend which has seen no growth in the stock of productive lending over the past 12 years.
This trend provides support for Minsky’s hypothesis that, over the course of a long financial cycle, there will be a shift towards riskier and more speculative sectors. The implications extend well beyond the over-valuation of residential property prices. Current private sector dynamics, fuelled in part by current policy, have negative implications for leverage, growth, financial stability and income inequality. Time for another policy reboot?
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
