Trends in financing flows (EUR bn) and nominal policy rates (%) (Source: ECB; CMMP)
The key message
The unprecedented speed of monetary policy transmission to the cost of borrowing for EA corporates and households and the subsequent collapse of private sector financing flows complicate policy options for the ECB going forward and raise the risks of policy errors considerably.
The combination of negative financing flows and policy rates that are at a historic high in nominal terms and the highest level since September 2007 in real terms is unlikely to be sustainable. This is before the pass through to the cost of borrowing for corporates and households is fully completed and taken into account.
Unfortunately, the ECB lacks a playbook for its unprecedented policy moves and their equally unprecedented consequences. EA economies also find themselves in uncharted territory. The risks of policy errors continue to mount.
Disappearing private sector financing flows – Part II
Cumulative 12-month financing flows to the EA private sector peaked at €811bn in September 2022, three months after the ECB began tightening policy rates. They turned negative in September 2023 (-€37bn) and remained negative in October 2023 too (-€5bn).
Unusually, negative financing flows coincide currently with policy rates that are high in both nominal and real terms. Current policy rates are at their highest nominal level (4.50%) since the introduction of the euro in 1999 (see key chart above). In real terms, the main policy rate is also at its highest level (1.55%) since September 2007 – albeit below April 2007’s peak real rate of 2.26% (see chart below).
Trends in financing flows (EUR bn) and real policy rates (%) (Source: ECB; CMMP)
The release of October 2023’s composite costs of borrowing for EA corporates and households is scheduled for 4 December 2023. Assuming no change from September (an unlikely assumption), the real cost of borrowing for corporates and households is relatively restrictive levels of 2.1% and 1.0% respectively already (due to the fall in inflation). This is before the full pass through to the cost of borrowing for corporates and households is taken into account (see chart below).
Trends in financing flows (EUR bn) and real NFC and HH borrowing costs (%) (Source: ECB; CMMP)
Conclusion
In short, the combination of negative financing flows and policy rates that are at a historic high in nominal terms and the highest level since September 2007 in real terms is unlikely to be sustainable.
Unfortunately, the ECB lacks a playbook for its unprecedented policy moves and their equally unprecedented consequences. EA economies also find themselves in uncharted territory. The risks of policy errors continue to mount.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Highlight the rising risks of unprecedented ECB policy tightening
The key chart
The collapse in financing flows to the EA private sector (Source: ECB; CMMP)
The key message
Cumulative 12-month financing flows to the euro area (EA) private sector were NEGATIVE in October 2023 for the SECOND CONSECUTIVE MONTH.
Cumulative flows to the private sector fell to NEGATIVE €5bn in October 2023, down from €764bn a year earlier
Cumulative flows to EA corporates (NFCs) fell to NEGATIVE €41bn in October 2023, down from €388bn a year earlier (and despite a positive monthly flow of €2bn)
Cumulative flows to the household (HH) sector slowed to €13bn from €264bn a year earlier (despite positive monthly flows in four of the past six months)
Mortgage market dynamics are the primary driver of HH flows. Cumulative mortgage flows fell to only €16bn, down from €241bn a year earlier. In contrast, consumer credit flows have remained relatively stable at over €20bn throughout 2023
Disappearing private sector financing flows reflect the unprecedented pace of the transmission of ECB policy to the cost of NFC and HH borrowing. They also highlight the rising risk of policy errors clearly….(see next post).
Disappearing private sector financing flows
Trends in cumulative 12-month flows (EUR bn) of loans to the EA private sector (Source: ECB; CMMP)
Cumulative 12-month financing flows to the private sector fell to NEGATIVE €5bn in October 2023, down from €764bn a year earlier (see chart above). This represents the second consecutive month of negative financing lows, after the negative €33bn in September 2023.
Trends in financing flows to the NFC sector (Source: ECB; CMMP)
Cumulative 12-month financing flows to EA corporates (NFCs) fell to NEGATIVE €41bn in October 2023, down from €388bn a year earlier and despite a positive monthly flow of €2bn (see chart above).
Trends in financing flows to the HH sector (Source: ECB; CMMP)
Cumulative 12-month financing flows to the household (HH) sector slowed to €13bn from €264bn a year earlier. This is despite positive monthly flows in four of the past six months (see chart above).
This slowdown is driven primarily by mortgage market dynamics. Cumulative mortgage flows fell to only €16bn, down from €241bn a year earlier (see chart below). Consumer credit flows have remained relatively stable at over €20bn throughout 2023, but remain below their pre-pandemic trends.
Slowdown in financing flows to the HH sector reflect mortgage market dynamics primarily (Source: ECB; CMMP)
Conclusion
The core “choke point” message from the EA money sector remains the same.
Disappearing private sector financing flows reflect the unprecedented pace of the transmission of ECB policy to the cost of NFC and HH borrowing. They also highlight the rising risk of policy errors clearly.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
The OBR’s latest UK forecasts seen from a sectoral balances perspective
The key chart
Historic and forecast trends in sectoral balances for the UK private and public sectors and the RoW expressed as % GDP (Source: OBR; CMMP)
The key message
Viewed from a sectoral balances perspective, the Office of Budget Responsibility’s (OBR’s) latest “Economic and Fiscal Outlook” for the UK appears “too dull to be true”.
Too dull to be true?
Sectoral balances illustrate the financial relationship between different economic sectors. Between the UK private sector (households and corporates), the UK public sector and the rest-of-the-world (RoW), for example, in the key chart above.
The approach builds on the key accounting identity pioneered by the late Wynne Godley that states that:
Domestic private balance + domestic public balance + foreign balance (must) = zero
Pre-COVID, the UK was characterised by unsustainable macro imbalances. Both domestic sectors were running net borrowing (or deficit) positions at the same time. This left the UK increasingly reliant on net lending from the rest-of-the world – the ultimate irony for “post-Brexit Britain”.
The pandemic changed everything. The private sector shifted to unprecedented levels of net lending/surpluses. At its peak in 2Q20, private sector surpluses/disinvestment totalled almost 25% GDP. Fortunately, the UK government’s response was timely, rapid and appropriate with an offsetting deficit/investment of 25% GDP (see key chart above).
Recent (post-pandemic) OBR outlooks forecast a return to the pre-COVID world of unsustainable macro imbalances. The latest version is more optimistic, thanks in part to improved household dynamics.
In short, the OBR forecasts a balanced UK private sector – a net lending position for the household sector of 1.3% GDP in 1Q29 down from 2.6% GDP in 2Q23, but close to average levels, and a return to investment or net borrowing by UK corporates equivalent to -0.9% GDP. The OBR also expects net borrowing by the government to fall from -7.3% GDP to only -0.7% GDP over the same period.
The OBR concludes that, “Following large swings during the pandemic and energy crisis, sectoral balances are expected to return to historically more normal levels over the forecast period.”
A more cynical observer may conclude that the forecasts are simply too dull and/or too smooth to be true…
Please note that the summary comments and chart above are abstracts from more detailed analysis that is available separately.
…but it only tells one part of the EA macro and banking story
The key chart
Growth trends (% YoY) in narrow money (M1) and other short term deposits (M2-M1) (Source: ECB; CMMP)
The key message
Recent events have bought renewed attention to monetary developments in the euro area (EA). One component of money supply captures the attention – narrow money or M1. The reasons are simple:
Growth in M1 is slowing at its fastest annual rate since the creation on the EMU
Real growth rates in M1 typically display leading indicator properties with real GDP
M1 dynamics make great headlines for sure, but they only tell one part of the current EA macro and banking story.
The rising opportunity cost of holding money, on-going portfolio rebalancing and the mechanics of money creation are important too. Together they provide critical context for understanding current EA monetary and macro developments fully:
Opportunity cost: unprecedented ECB tightening has increased the opportunity cost of holding money and triggered a partial re-allocation of ON deposits to better-remunerated, other ST deposits (see key chart above)
Portfolio rebalancing: the phasing out of net asset purchases and TLTROs has incentivised bond issuance and encouraged portfolio rebalancing away from deposits to LT bank liabilities, (note, the latter do not form part of monetary aggregates by definition)
Money creation: bank lending is the principal source of money creation (deposits). Growth in private sector credit has slowed from 7.1% YoY in September 2022 to only 0.3% YoY in September 2023.
The slowdown in M1, while dramatic, is neither an indicator of liquidity problems for EA banks nor a reliable indicator of economic activity or future inflation. At least, not in itself.
Last month’s money flow data illustrates this well. Despite on-going outflows of overnight deposits, M3 (the ST liabilities of the banking system) increased by €73bn in September 2023 and bank liability flows totalled €134bn.
Policy normalisation leads to natural re-adjustments in the structure and dynamics of MFI consolidated balance sheets (see future posts). This can and does create dramatic movements in individual items and monetary variables such as M1 and increases the risk of misinterpretation.
Context is required, therefore, including full analysis and understanding of both the components and counterparts of money supply.
In short, monetary aggregates still matter. They tell us a great deal about the interaction of the banking sector and the wider economy, but they need interpreting with due care and attention…
Narrow money (M1) fell by -10.4% in August 2023 (a record, see chart above) and by -9.9% in September 2023, driven by sharp declines in the level of overnight deposits (-12.0% and -11.4% respectively).
Broad money growth (% YoY) and contribution breakdown by component (ppt) (Source: ECB; CMMP)
The chart above illustrates the contribution of the three components of money supply – narrow money (M1), other short-term deposits (M2), and marketable instruments (M3-M2).
With M1 contributing -7.2ppt to an overall -1.2% on broad money, it is immediately clear that other important dynamics are at play here. These include the rising opportunity cost of holding overnight deposits, on-going portfolio rebalancing and the mechanics of money creation.
Opportunity cost
Growth trend (% YoY) in other ST deposits (M2-M1) (Source: ECB; CMMP)
Unprecedented tightening by the ECB has led to a rapid increase in the opportunity cost of holding overnight deposits. This is in sharp contrast to most of the past decade. This has triggered a partial reallocation of ON deposits to better-remunerated, other ST deposits. M2-M1 has been growing by more than 20% YoY since March 2023 and grew at a record rate of 24% YoY in June 2023 (see chart above).
Portfolio rebalancing
Trends in stock (EUR bn) and annual growth rate (% YoY) of LT debt securities (Source: ECB; CMMP)
The phasing out of net asset purchases and TLTROs has incentivised the issuance of bank bonds (see chart above). This has led to a portfolio rebalancing away from deposits to longer-term liabilities that do not form part of monetary aggregates, by definition. (See “Happier times ahead for FIG DCM bankers“, August 2023.)
Mechanics of money creation
PS credit growth (% YoY) and contribution breakdown by component (ppt) (Source: ECB; CMMP)
The principal way in which bank deposits are created is through commercial banks making loans. Banks are not simply intermediaries that take in deposits and then lend them out (“loanable funds theory”). Banks create money instead. Growth in private sector credit peaked, however, in September 2022 (7.1% YoY) and has slowed to 0.3% YoY in September 2023 (see chart above).
What does this mean for monthly financing?
Monthly financing flows (EUR bn) for September 2023 (Source: ECB; CMMP)
The table above illustrates monthly financing flows to the euro area and highlights the working of these dynamics in practice.
Outflows of M1 fell from €75bn in August 2023 to €5bn in September 2023
At the same time, flows into M2-M1 increased from €39bn to €74bn, while flows into M3-M2 totalled €4bn
Hence, on a net basis, flows into the ST bank liabilities (“money”) were €73bn
Note that flows of LT liabilities also increased to €38bn in September 2023, comprising €18bn of deposits with maturity of over 2 years and €14bn of debt securities with a maturity of over two years.
Conclusion
Policy normalisation leads to natural re-adjustments in the structure and dynamics of MFI consolidated balance sheets (see future posts). This can and does create dramatic movements in individual items and monetary variables such as M1 and increases the risk of misinterpretation.
Context is required, therefore, including full analysis and understanding of both the components and counterparts of money supply.
In short, monetary aggregates still matter. They tell us a great deal about the interaction of the banking sector and the wider economy, but they need interpreting with due care and attention…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Have US consumers finally read the recession script?
The key message
Quarterly US consumer credit flows (Source: FRED; CMMP)
The key message
Have US consumers finally read the recession script?
Quarterly US consumer credit flows slowed to only $4bn in 3Q23, down from $26bn in 2Q23 and $52bn in 1Q23 (see key chart above). These latest quarterly flows are the weakest since 2Q20, and represent only a very small fraction of the pre-pandemic average quarterly flow of $45bn.
Monthly US consumer credit flows (Source: FRED; CMMP)
Monthly flows were volatile during the 3Q23 (see chart above). The flow of consumer credit recovered in September to £9bn after repayment of $16bn in August, but remained below July’s flow of $11bn. Three-month moving average flows fell steadily, however, from $7.8bn in July to $2.8bn in August and $1.8bn in September. These smoothed flows compare with the pre-pandemic average of $14.8bn.
So what?
In recent quarters, we noted the sharp moderation in US consumer credit demand. Weakness in the 3Q23 and revised figures for 2Q23 (revised lower) indicate much weaker dynamics and elevated risks to US consumption and the growth outlook.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
UK and EA consumers are still borrowing, despite higher rates
The key chart
Quarterly flows in UK and EA consumer credit (multiple of pre-pandemic flows) (Source: BoE; ECB; CMMP)
The key message
The Bank of England and ECB both argue that, (1) the best way they can make sure inflation comes down and stays down is to raise rates, and (2) that higher rates make it more expensive to borrow and hence people will spend less on goods on services.
Great in theory, but consumer credit flows have remained surprisingly strong during 3Q23 and in September 2023 when monthly flows in both regions were 1.2x their average pre-pandemic levels.
While unprecedented increases in the cost of borrowing have resulted in a very sharp slowdown in overall financing flows to the UK and EA private sectors, consumers in both regions are “still bashing the plastic”.
Bad news for investment and real estate, perhaps, but better news for consumer goods and services (at least for now).
And yet
“Higher interest rates make it more expensive for people to borrow money and encourages them to save. That means that, overall, they will tend to spend less. If people on the whole spend less on goods and services, prices will tend to rise more slowly. That lowers the rate of inflation”
Bank of England, 2 November 2023
UK consumer credit flows
UK consumer credit flows totalled £4.4bn in 3Q23, up from £4.3bn in the 2Q33, but down from £4.5bn in 1Q23 (see key chart above). Consumer credit flows in the past three quarters have been 1.2x their average pre-pandemic level of £3.6bn.
Trends in UK monthly consumer credit flows (Source: BoE; CMMP)
Monthly consumer credit flows during the 3Q23 were £1.3bn in July, £1.7bn in August, and £1.4bn in September. These resilient flows were 1.1x, 1.4x and 1.2x the average monthly pre-pandemic flow of £1.2bn (see chart above).
EA consumer credit flows
EA consumer credit flows totalled €9.3bn in 3Q23, up from €3.4bn in 2Q23 and €4.2bn in 1Q23. Consumer credit demand, which had been supressed since the pandemic, almost recovered to its pre-pandemic average level of €10.3bn.
Trends in EA monthly consumer credit flows (Source: ECB; CMMP)
Monthly consumer credit flows during the 3Q23 were €2.5bnbn in July, £3.0bn in August, and £3.9bn in September. These flows were 0.7x, 0.9x and 1.2x the average monthly pre-pandemic flow of €3.4bn (see chart above).
Conclusion
While unprecedented increases in the cost of borrowing have resulted in a very sharp slowdown in overall financing flows to the UK and EA private sectors, consumers in both regions are “still bashing the plastic”.
Bad news for investment and real estate, perhaps, but better news for on-going demand for goods and services.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
(Some) things may not be getting worse, but significant financing challenges remain
The key chart
Trends in net lending flows to UK SMEs (Source: BoE; CMMP)
The key message
There was little for UK SMEs to cheer in the latest “Money and Credit” data release from the Bank of England. The only positives for this systemically important economic sector were: (1) monthly negative financing flow dynamics did not get worse; and (2) the average cost of borrowing fell slightly.
SMEs have been repaying bank loans and overdrafts since October 2022. In September 2023, net repayments totalled -£284m, less than -£747m in August and -£1,184m in July
Cumulative flows in the twelve months to September 2023 increased to -£9.9bn from -£9.2bn and -£8.8bn in August and July respectively, however
Note that lending to real estate activities (that involve buying, selling and renting of own or leased real estate) is the only sub-sector to experience positive 12-month cumulative lending flows (£0.3bn in September 2023). With monthly repayments in four of the past six months, these cumulative flows are slowing sharply now, reflecting wider challenges for the sector
The average cost of borrowing for SMEs fell slightly from 7.65% in August to 7.59% in September 2023. Nonetheless, the 514bp increase in the cost of borrowing since the Bank of England began tightening is still larger than for all corporates (460bp to 6.63%), secured HH borrowing (343bp to 5.01%) an unsecured HH borrowing (246bp to 8.73%).
In short, and to repeat recent messages, UK SMEs continue to face significant systemic and cyclical financing challenges that limit their ability to invest fully in growth, job creation and innovation. Are the UK government and the Bank of England watching carefully enough…?
Little to cheer for UK SMEs
Trends in net lending flows to UK SMEs (Source: BoE; CMMP)
SMEs have been repaying bank loans and overdrafts since October 2022. In September 2023, net repayments totalled -£284m, compared with -£747m in August 2023 and -£1,184m in July 2023 (see columns in chart above).
Cumulative flows in the twelve months to September 2023 increased to -£9.9bn from -£9.2bn and -£8.8bn in August 2023 and July 2023 respectively (see dotted line in chart above).
Trends in net lending flows to key RE sub-sector (Source: BoE; CMMP)
Dynamics in the two sectors that have the largest market shares of total loans – real estate (41% share) and trade (9% share) – matched the overall sector dynamics (unsurprisingly given their size).
Note however that real estate comprises two subsectors: the first and largest involves buying, selling and renting of own or leased real estate; the second (much smaller) involves real estate activities on a fee or contractual basis.
The former is the only sub-sector within SME lending to experience positive 12-month cumulative lending flows (£0.3bn in September 2023). With monthly repayments in four of the past six months, these cumulative flows are slowing sharply now reflecting wider challenges for the UK real estate sector (see chart above).
Trend in the average cost of borrowing for UK SMEs (Source: BoE; CMMP)
The average cost of borrowing for SMEs fell slightly from 7.65% in August 2023 to 7.59% in September 2023 (see chart above). Nonetheless, the 508bp increase in the cost of borrowing since the Bank of England began tightening is still larger than the average costs of borrowing for all corporates (460bp to 6.63%), secured HH borrowing (343bp to 5.01%) an unsecured HH borrowing (246bp to 8.73%).
Changes in the cost of borrowing since BoE tightening began by sector (Source: BoE; CMMP)
Conclusion
To repeat last month’s message – SME’s access to finance is systemically important to the UK economy. Broad-based weakness in lending across all SME sectors or industry groups is concerning, therefore. It supports the hypothesis that SMEs are putting both investment and business development on hold.
In short, current financing conditions are limiting SMEs’ ability to invest fully in growth, job creation and innovation. Are the UK government and the Bank of England watching carefully enough…?
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
