“Not what the doctor ordered”

Rising UK COVID-19 risks come at an unfortunate time

The key chart

**Trends in monthly HH money flows (£bn) compared to 2019 average monthly flows** (Source: BoE; CMMP)

The key message

The rise in COVID-19 cases and the discovery of the new Omicron variant come at a delicate and unfortunate time for the UK economic recovery (and associated recovery trades).

According to the Bank of England’s latest “Money and Credit” release for October 2021, monthly household money flows were moderating and demand for consumer credit was recovering at the start of 4Q21 – positive trends in two of our three key signals for 2021. So called “faster indicators” such as credit and debit card payments also indicate that positive trends continued into mid-November 2021.

There is never a good time for COVID-related risks to be rising, but it is particularly unfortunate that the threat of renewed uncertainty and restrictions on economic activity has coincided with an apparent inflexion point in the messages from the UK money sector.

Not what the doctor ordered in either a literal or metaphorical sense.

Not what the doctor ordered

The rise in COVID-19 cases and the discovery of the new Omicron variant come at a delicate and unfortunate time for the UK economic recovery and associated recovery trades.

**COVID cases and deaths (7 day MVA) in the UK** (Source: UK government; CMMP)

The number of people who tested positive has risen to 42, 583 according to the latest data provided on 29 November 2021. This represents an increase of 4,574 cases (12%) since the end of October 2021 (see chart above). In response to the identification of the new variant, the UK government has tightened restrictions on face coverings and entry into the UK. The booster programme for vaccines has also been accelerated. It remains too early to know if further restrictions will be required.

Why the timing is so bad

**Key signal #1: looking for a moderation in HH money flows** (Source: BoE; CMMP)

According to the Bank of England’s latest “Money and Credit” release for October 2021, monthly household money flows slowed sharply at the start of 4Q21.

These flows represent a useful proxy for household uncertainty. They peaked at £28bn (6x pre-pandemic levels) in May 2020 and again at £21bn (4x pre-pandemic levels) in December 2020. Note that money flows combine forced and precautionary elements of household savings. During periods of “lockdown” (see black bars in chart above), they averaged 4x their pre-pandemic levels reflecting the added impact of forced savings. Between lockdowns and since lockdowns they have averaged 2x their pre-pandemic levels.

Monthly flows fell from £9bn (2x pre-pandemic levels) in September 2021 to £5bn (1.2x pre-pandemic levels) in October 2021, the lowest monthly flow since February 2020.

**Key signal #2: looking for a recovery in consumer credit demand (£bn LHS, % YoY RHS)** (Source: BoE; CMMP)

UK households borrowed £0.7bn in consumer credit in October 2021, the strongest net borrowing since July 2020 (see chart above). Monthly flows have been positive since April 2021 – seven consecutive months of positive net borrowing. The majority of this borrowing (£0.6bn) was additional borrowing on credit cards, which was also the strongest since July 2020 (£0.9bn).

The annual growth rate in consumer credit remains negative, however (green line in chart above). That said, the YoY growth rate has narrowed to -1.0% in October from -1.7% in September and the low of -9.1% in January 2021.

**Credit and debit card payments (7d rolling average) in aggregate and on delayable goods in relation to pre-pandemic levels** (Source: ONS; CMMP)

So called “faster indicators” such as credit and debit card payments also indicate that these positive trends continued into mid-November 2021. After a sharp recovery in payments in March and April 2021 (following the easing of restrictions) momentum slowed in 2Q21 and 3Q21. Aggregate card payments rebounded in November, however, to reach 103% of pre-pandemic levels (see chart above).

**The build up in excess HH savings (£bn) during the COVID-19 pandemic** (Source: BoE; CMMP estimates)

Spending on “delayable” goods such as clothing and furniture has also recovered to 104% of pre-pandemic levels during November. This matters because spending on delayable goods is a useful indicator regarding the extent to which the £160bn in excess savings built up during the pandemic is returning to the economy via household consumption. The evidence to date is that while the build up of excess savings has slowed, this cash has yet to be spent (see chart above). A positive note to carry into the new year.

Conclusion

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

“Enough is enough”

Growth in the wrong type of lending triggers ECB call for policy shift

The key chart

**Growth rates (% YoY) in average RRE prices and loans for house purchase** (Source: ECB; CMMP)

The key message

In its latest “Financial Stability Review” (November 2021), the ECB calls for a policy shift away from short term support measures towards “mitigating risks from higher medium term financial stability vulnerabilities, in particular emerging cyclical and real estate risks.”

This is a welcome development given the extent to which (unorthodox) policy measures have fuelled growth in the “wrong type of lending” to date, and the negative implications this has for future growth, leverage, financial stability and income inequality.

Macroprudential instruments include capital measures (e.g. higher risk weights) and borrower-based measures (e.g. LTV limits). Their adoption varies across the euro area currently, with six economies adopting a combination of both instruments, nine economies adopting borrower-based measures alone, and four economies having no measures in place (Germany, Spain, Italy and Greece).

Further tightening of existing instruments may be required in several economies where RRE vulnerabilities are continuing to build up, but Germany stands out given current house price and lending dynamics, the extent of RRE overvaluation and the absence of targeted macroprudential measures.

“Enough is enough”

Over the past two years, I have been highlighting the hidden risk that unorthodox monetary policies in the euro area (and elsewhere) were fuelling growth in the “wrong type of lending”. From this, I have argued that the resulting shift from productive COCO-based lending towards less-productive FIRE-based lending (see chart below) has negative implications for leverage, growth, financial stability and income inequality in the future.

**Outstanding stock of private sector lending (EUR bn, LHS) broken down by type and share of FIRE-based lending in total lending (%, RHS)** (Source: ECB; CMMP)

Earlier this month, I also argued that it was appropriate, therefore, to expect new macroprudential measures for residential real estate soon. The ECB agrees (finally). In their latest “Financial Stability Review” (November 2021), the ECB is calling for a policy shift away from short-term support towards mitigating risks from higher medium-term financial stability vulnerabilities including residential real estate (RRE) risks.

**2Q21 RRE price growth (% YoY) plotted against level of pre-pandemic valuation** (Source: ECB; CMMP)

The ECB’s analysis includes three key risk factors:

First, nominal house prices grew at 7.3% in 2Q21, the fastest rate of growth since 2005 (see key chart above)

Second, house price and lending dynamics have been much stronger in many countries with pre-existing vulnerabilities. For example, despite above average degrees of over-valuation pre-pandemic (ie, >4% estimated overvaluation), RRE prices grew at above-average rates (ie, >7% YoY) in Luxembourg, the Netherlands, Austria, Germany, and Belgium in the year to end 2Q21 (see chart above)

Third, there is evidence of a progressive deterioration in lending standards, as reflected in the increasing share of loans with high LTV ratios. The share of new loans with LTVs above 90% reached 52% in 2020 compared with only 32% in 2016 (see chart below)

The ECB also notes “high and rising levels of HH indebtedness”, but this is less of a risk, in my opinion, given that the HH debt ratio of 61% GDP is well below the BIS’ threshold of 85% GDP.

**Share of loans with LTV >90% in total new loan production** (Source: ECB; CMMP)

Macroprudential instruments include capital measures (eg higher risk weights) and borrower-based measures (eg, LTV limits). Their adoption varies across the euro area with six economies adopting a combination of both instruments (green bubbles in chart below), nine economies adopting only borrower-based measures (orange bubbles in chart below), and four economies having no measures in place – Germany, Spain, Italy and Greece (red bubbles in chart below, although Greece not shown).

**RRE price growth plotted against mortgage loan growth 1H21 v 1H20. Size of bubbles represents HH debt ratio and colour represents current macroprudential framework** (Source: ECB; CMMP)

Further tightening of existing instruments may be required in several economies where RRE vulnerabilities are continuing to build up, but Germany stands out given the combination of house price and lending dynamics, the extent of overvaluation and the lack of macroprudential measures.

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

“How much? How productive?”

ECB claims from a CMMP perspective

The key chart

**Annual growth (% YoY) in EA private sector lending split between FIRE-based and COCO-based lending** (Source: ECB; CMMP)

The key message

Is the ECB correct to argue that, “monetary policy measures continue to support lending conditions and volumes” in the euro area? Yes, but only up to a point.

On the supply-side, the APP, PEPP and TLTRO III programmes are having a positive impact on banks’ liquidity positions and overall market financing conditions. On the demand side, borrowing costs are at (mortgages) or close to (NFC loans) historic lows in nominal terms and at historically low and negative levels in real terms. So far, so good.

That said, lending volumes are unexciting in relation to recent trends and previous cycles and currently negative in real terms. No compelling volume story here.

More importantly, current policy measures are supporting the “wrong type of credit”.

Less-productive lending that supports capital gains through higher asset prices (FIRE-based lending) contributed 2.5ppt to the 3.2% total loan growth in September 2021. Worryingly, this is part of longer-term trend. While the outstanding stock of private sector loans hit a new high in September, the stock of productive lending that supports production and income formation (COCO-based lending) remains below its January 2009 peak.

This matters for two key reasons. First, the shift from COCO-based lending to FIRE-based lending has negative implications for leverage, growth, financial stability and income inequality (expect new macroprudential measures for residential real estate soon). Second, it re-enforces the importance of an on-going policy response that remains “fiscal, first and foremost”.

“How much? How productive?”

In its latest “Euro area bank lending survey”, the ECB argues that, “monetary policy measures continue to support lending conditions and volumes” in the euro area (EA). Is this correct?

The supply-side

**“Liquidity-providing” monetary policy operations in EUR bn** (Source: ECB; CMMP)

On the supply-side, EA banks report that “the ECB’s asset purchase programme (APP), the pandemic emergency purchase programme (PEPP), and the third series of targeted longer-term refinancing operations (TLTRO III) continues to have a positive impact on their liquidity positions and market financing conditions” (see chart above).

The demand-side

**Composite cost-of borrowing for house purchases and NFC loans in nominal and real terms** (Source: ECB; CMMP)

One the demand side, borrowing costs are at (mortgages) or close to (NFC loans) historic lows in nominal terms and at historically low and negative levels in real terms (see chart above). In September 2021, the composite cost-of-borrowing for house purchases hit a new low of 1.30% (-2.03% in real terms). The composite cost of borrowing for NFC’s was 1.48%, 0.8ppt above its March 2021 low, but a new low in real terms (-1.86%).

How exciting is the volume story?

**Annual growth (% YoY) in private sector lending in nominal and real terms** (Source: ECB; CMMP)

Lending volumes are unexciting in relation to recent trends and previous cycles and currently negative in real terms. Lending to the private sector grew 3.2% YoY in September 2021 both on a reported basis and after adjusting for loan sales and securitisation. In nominal terms, lending growth has been relatively stable since March 2021 but is 2ppt lower than the recent peak growth recorded in May 2020 (5.2% YoY). Lending growth in the current cycle is relatively subdued, however, in relation to past cycles (see chart above). Furthermore, in real terms, lending in September fell slightly when adjusted for HICP inflation.

No compelling volume story here.

Loan growth from the ECB perspective

**Annual loan growth with ECB breakdown by borrower** (Source: ECB; CMMP)

As an aside, the ECB typically classifies lending by type of borrower – households (HHs), non-financial corporations (NFCs), non-monetary financial corporations (NMFCs) and insurance companies and pension funds (ICPFs) – with further subdivisions based in the type of HH borrowing and the maturity of NFC borrowing.

In September 2021, HH lending contributed 2.2pt to the total 3.2% YoY growth, essentially mortgages. NFCs and NMFCs contributed 0.6ppt and 0.5ppt respectively but lending to ICPFs made a slight negative contribution of -0.1ppt.

Loan growth from the CMMP Perspective

CMMP analysis presents an alternative classification based on the productivity of credit use. Broadly speaking, lending can be spilt into two distinct types: lending to support productive enterprise; and lending to finance the sale and purchase of existing assets. The former includes lending to NFCs and HH consumer credit (and other HH lending) and is referred collectively here as “COCO-based” lending (COrporate and COnsumer). The latter includes loans to non-bank financial institutions (NBFIs) and HH mortgage or real estate debt and is referred collectively here as “FIRE-based” lending (FInancials and Real Estate).

Note that COCO-based lending typically supports production and income formation while FIRE-based lending typically supports capital gains through higher asset prices.

Supporting the “wrong type of credit”

**Annual loan growth with CMMP breakdown by productivity of use** (Source: ECB; CMMP)

Viewed from a CMMP perspective, current policy measures are supporting the “wrong type of credit”. Less-productive lending that supports capital gains through higher asset prices (FIRE-based lending) contributed 2.5ppt to the 3.2% total loan growth in September 2021 (see chart above).

**Annual loan growth broken down by productivity of use since September 2006** (Source: ECB; CMMP)

Worryingly, this is part of a longer-term trend. As can be seen from the chart above, higher volumes in the pre-GFC period were more balanced with more-productive COCO-based lending accounting for 56% of total outstanding loans. Today, that share has fallen to 48%.

**Outstanding stock (EUR bn) of COCO-based lending** (Source: ECB; CMMP)

As noted in August 2021, while the outstanding stock of credit hit a new high in September, the stock of productive COCO-based lending (€5,470bn) remains below its January 2009 peak (€5,517bn). In other words, the aggregate growth in lending since early 2009 has come exclusively from FIRE-based lending which now accounts for 52% of the outstanding stock of loans (see chart below).

**Outstanding stock (EUR bn) of COCO-based and FIRE-based lending** (Source: ECB; CMMP)

Conclusion

The ECB is entitled to argue that monetary policy measures have supported lending conditions and volumes. However, current lending volumes are unexciting in relation to previous cycles and negative in real terms. Policy is also supporting the “wrong type” of credit – fuelling FIRE-based lending rather than productive COCO-based lending that supports production and income formation.

This matters for two key reasons. First, the shift from COCO-based lending to FIRE-based lending has negative implications for leverage, growth, financial stability and income inequality. During the COVID-19 pandemic, some national authorities eased macroprudential measures for residential real estate (RRE). This week, however, the ECB argued that further macroprudential measures should be considered where RRE vulnerabilities continue to build up. (Watch this space.) Second, it re-enforces the importance of an on-going policy response that remains “fiscal, first and foremost”.

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