Month: December 2023

“Seven lessons from the money sector in 2023”

What have the “messages from the money sector” taught us in 2023?

The key chart

Visual summary of the CMMP Analysis framework linking all economic sectors together (Source: CMMP)

The key message

The key message from CMMP Analysis is that the true value in analysing developments in global finance lies less in considering investments in banks’ equity and more in understanding the implications of the relationship between the money sector and the wider economy for macro policy, corporate strategy, investment decisions and asset allocation.

The 2023 “messages from the money sector” included the importance of post-GFC debt dynamics, the risks of policy errors, the failure of banks to support productive economic activities, and the increasing abuse of macro statistics.

The seven key lessons were:

  1. The risk of a Chinese balance sheet recession dominated 2023 and will DOMINATE 2024 too
  2. “US bears” ignored structural shifts in US debt dynamics post-GFC and underestimated the RESILIENCE OF THE CONSUMER as a result
  3. Aggregate demand in credit-driven economies is equal to income (GDP) PLUS THE CHANGE IN DEBT. Policy makers continue to ignore this truism at OUR peril
  4. The ECB’s policy celebrations may prove PREMATURE
  5. UK policy making is still based on UNBELIEVABLE forecasts and FLAWED macro thinking
  6. Banks are failing to support PRODUCTIVE ACTIVITY and the SME sector in particular
  7. The ABUSE of macro statistics is rife – beware of “panic charts” and their accompanying narratives

Seven lessons from the money sector in 2023

The importance of post-GFC debt dynamics

Lesson #1: the risk of a Chinese balance sheet recession dominated 2023 and will dominate 2024 too

January 2023: Trends in Japanese, Spanish and Chinese private sector debt ratios (% GDP) (Source: BIS; CMMP)

CMMP Analysis began 2023 by questioning the popular, “China-opening story“. We highlighted three structural risks to this narrative – (1) the level of private sector debt, (2) the rate of growth of household debt, and (3) the affordability of private sector debt. We asked two questions.

First, what happens if rather than seeking to maximise profit/utility as traditional economics assumes, the Chinese private sector turns to minimising debt or maximising savings instead?

Second, and following on from this, what if China experiences a balance sheet recession instead?

December 2023: Trends in “excess credit growth” in China since June 2013 (Source: BIS; CMMP)

The balance sheet narrative remained on hold during 2023, but risks remain as we enter 2024. All sectors of the Chinese economy are increasing leverage still. The Chinese government is the main driver here, rather than the private sector, however. Crucially, the dynamics of Chinese money creation and potential growth are shifting. Credit agencies may (mistakenly) wish for lower levels of government debt in China, but given current debt dynamics it will be fiscal policy/government spending that will have to do the heavy lifting in 2024 if China’s growth is to recover.

Lesson #2: “US bears” ignored structural shifts in US debt dynamics post-GFC and underestimated the resilience of the consumer as a result

January 2023: Trends in the stock of US consumer credit ($tr) and the consumer credit to DPI ratio (%) (Source: FRED; CMMP)

CMMP Analysis also began 2023 by questioning the equally popular, “US consumer slowdown narrative”. We argued that “US bears” were ignoring the key structural shifts in US debt dynamics that saw the US leading the advanced world in the structural shift away from high-risk HH debt towards relatively low risk public debt in the post-GFC period. In September 2023, we noted greater affordability risks in other developed economies such as Canada, Switzerland, Sweden, France and Finland and in emerging markets such as Brazil, China and Korea instead.

December 2023: Trends in monthly flows of US consumer credit (Source: FRED; CMMP)

That said, we also noted signs that the US consumer was starting to crack as the year progressed. Quarterly consumer credit flows in the 3Q23 ($4bn) were the weakest since 2Q20, and only a very small fraction of the pre-pandemic average quarterly flow of $45bn. Monthly flow data for October 2023, also suggested that momentum weakened further at the start of 4Q23.

Note the key differences between China and the US here – China’s challenges are more structural in nature, while the US’s challenges are more cyclical.

The risks of policy errors

Lesson #3: Aggregate demand in credit-driven economies is equal to income (GDP) PLUS THE CHANGE IN DEBT. Policy makers continue to ignore this truism at OUR peril.

In September 2023, CMMP Analysis argued that central bank decision making that appears largely “data independent” in relation to private sector credit dynamics is unlikely to produce positive economic outcomes. Instead, it increases the likelihood of policy errors, especially in credit-driven economies.

September 2023: Trends in the UK PS debt ratio (RHS) and PSC relative growth factor (LHS) (Source: BIS; CMMP)

The fundamental error is to ignore that aggregate demand in a credit-driven economy is equal to income (GDP) PLUS THE CHANGE IN DEBT. The addition of the change in debt means that, in reality, aggregate demand is far more volatile than it would be if income alone was its source (as typically assumed). This is especially true for highly indebted economies.

If Schumpeter could understand this in 1934, why can’t policy makers understand it in 2024?

Lesson #4: The ECB’s celebrations may prove to be premature

ECB officials spent much of 2023 arguing that the transmission of monetary policy was working. The tone became almost celebratory by the end of the year, with Board members arguing that not only was the transmission working but also that it was delivering results that were EXACTLY what the ECB wanted to see.

December 2023: Trends in PS financing flows (EUR bn, 12m cum flows) and nominal NFC and HH borrowing costs (%, RHS) (Source: ECB; CMMP)

The risks that these celebrations may prove to be premature are obvious, however, or at least they should be. While monetary policy transmission in the euro area is working as textbooks suggest, both the pace and scale of current tightening is unprecedented. The ECB lacks a playbook for such a scenario and EA economies now find themselves in uncharted territory. Policy tightening continued even as the EA money sector was indicating increases stresses for banks, households and corporates. The end result – a combination of NEGATIVE financing flows to the private sector, historically high policy rates and elevated costs of borrowing – is unlikely to be sustainable in 2024.

Lesson #5: UK policy making is based on unbelievable forecasts and flawed macro thinking

November 2023: Historic and forecast trends in sectoral balances for the UK private and public sectors and the RoW expressed as % GDP (Source: OBR; CMMP)

Official OBR forecasts for the UK economy remain unbelievable when viewed through CMMP Analysis’ preferred sector balances perspective. The March 2023 version suggested a return to the pre-pandemic world of economic imbalances and an economy forecast to remain heavily dependent on net borrowing from abroad – the irony of post-Brexit Britain. The November 2023 version presented a more balanced outlook and a more realistic forecast for private sector dynamics but was simply too dull to be true.

December 2023: Trends in UK PS debt ratio (% GDP, RHS) and relative growth versus nominal GDP (3Y CAGR %, LHS) (Source: BIS; CMMP)

The UK private sector debt ratio fell back to its March 2022 level at the end of 2Q23. This matters because neither Jeremy Hunt (the current UK Chancellor) nor Rachel Reeves (his likely successor) appear to recognise the folly of combining austerity with private sector deleveraging (“pre-COVID Britain”). The next general election will be fought on the wrong macro battleground as a result. Both parties will repeat the flawed narrative that governments (that enjoy monetary sovereignty) face the same financial constraints as households and that public debt is a problem while largely ignoring private debt. A depressing thought for the year ahead.

The failure of banks

Lesson #6: Banks are failing to support productive activity and the SME sector in particular

February 2023: Trends and breakdown of UK FIRE-based (red and pink) and COCO-bases (blue) lending (£bn) (Source: BoE; CMMP)

A more appropriate macro policy debate in the run-up to the next election would focus on the role of banks. UK banking, for example, is heavily geared towards less-productive FIRE-based lending that supports capital gains rather than productive COCO-based lending that supports investment, production and income formation.

October 2023: Trend in the outstanding stock of SME loans since 2013 (£bn) (Source: BoE; CMMP)

UK banking also fails SMEs, the lifeblood of the UK economy. Only 22 pence in every pound lent in the UK is for productive purposes and only c.7pence is lent to SMEs. This is despite the fact that SMEs account for 50% of private sector turnover and 60% of employment. SMEs cannot invest fully in growth, job creation, innovation and equality if and when: (1) their access to external capital is constrained by LT structural factors; (2) flows of financing (both loans and overdrafts) are negative; and (3) their cost of borrowing is rising so rapidly.

The abuse of macro statistics

Lesson #7: The abuse of macro statistics is rife – beware of “panic charts” and their accompanying narratives.

CMMP Analysis suggests that US public sector debt and trends in narrow money (M1) are the most widely abused macro statistics of the year.

May 2023: 50 years of US public sector debt dynamics – plotted differently! (Source: FRED; CMMP)

The abuse of US public sector debt data involves five elements. First, ignoring the fact that public debt is both a liability for the government sector and an asset of the non-government sector. Second, making no comparison with GDP. Third, ignoring inflation. Fourth, presenting long time series data using linear scales. Fifth and finally, ignoring private sector debt dynamics completely (see also lesson #2 above).

November 2023: Growth trends (% YoY) in narrow money (M1) and other short term deposits (M2-M1) (Source: ECB; CMMP)

The abuse of monetary aggregate statistics is more understandable given that growth in narrow money is falling rapidly, and that real growth rates in M1 typically display leading indicator properties with real GDP. This means that M1 dynamics make great headlines for sure, but they only tell one part of the macro and banking stories. The rising opportunity cost of holding money, on-going portfolio rebalancing and the mechanics of money creation are important too. Policy normalisation leads to natural re-adjustments in the structure of MFI consolidated balance sheets. This can and does create dramatic movements in individual items and monetary variables such as M1 and increases the risk of misinterpretation.

In short, monetary aggregates still matter. To return to the key message from CMMP Analysis, 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…

Thank you for reading and very best wishes for a very happy and healthy new year.

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

“Shout it out loudly!”

The UK private sector debt ratio is back to March 2002 levels

The key chart

Trends in UK private sector debt ratio (% GDP, RHS) and relative growth versus nominal GDP (3Y CAGR %, LHS) (Source: BIS; CMMP)

The key message

Don’t whisper it softly this time – shout it out loudly instead:

…the UK private sector debt ratio is back to March 2002 levels

This matters because neither Jeremy Hunt (the current UK Chancellor) nor Rachel Reeves (his likely successor) appear to recognise the folly of combining austerity with private sector deleveraging (“pre-COVID Britain”). The next election will be fought on the wrong macro battleground as a result.

According to the latest BIS data release, the UK private sector’s debt ratio was 147% GDP at the end of 2Q23, down from its all-time high of 186% GDP in 1Q10 and its recent high of 177% GDP in 1Q21 (see key chart above).

The corporate sector debt ratio has fallen from 90% GDP in 4Q08 to 66% GDP in 2Q23, while the household sector debt ratio has fallen from 98% GDP in 4Q09 to 81% in 2Q23. The UK now joins the US, Germany and Italy among the small group of advanced nations where both sector’s debt ratios are below the BIS threshold limits, above which debt is considered a drag on future growth.

Note that the private sector’s share of total UK debt has fallen from almost 80% at the time of the GFC to 62% now. In short, the UK has followed the US in substituting higher-risk household debt with lower risk government debt since the GFC.

As the UK approaches a general election next year, the macro policy debate should be around:

UK banking is geared currently towards less-productive FIRE-based lending that supports capital gains rather than productive COCO-based lending that supports investment, production and income formation. UK banking also fails SMEs – the lifeblood of the UK economy. Only 22 pence in every pound lent in the UK is for productive purposes and only 7 pence is lent to SMEs. This is despite the fact that SMEs account for 50% of private sector turnover and 60% of employment.

Equally troubling, the UK policy debate focuses on reducing the level of government borrowing further based on the flawed narrative that governments face the same financial constraints as households and equally flawed macro thinking that sees public debt as a problem while largely ignoring private debt. The irony for “post-Brexit” Britain is that this leaves us increasingly dependent on financial flows from the RoW. A depressing thought at the end of the year.

Time for shouting not whispering…

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

“Whisper it softly – Part IV”

The “emerging market” classification has been redundant for some time now

The key chart

Trends in market share (%) of global debt since June 2009 (Source: BIS; CMMP)

The key message

Whisper it softly; the “emerging market” (EM) classification has been redundant for some time now.

CMMP analysis has questioned the relevance and usefulness of the “emerging market” classification for some time. The latest BIS data release, merely supports this view, at least from a debt perspective.

EM’s share of global debt has increased from 18% in June 2009 (at the time of the GFC) to 40% in June 2023 – a remarkable structural shift (see key chart above).

Over this period the EM debt ratio has risen from 97% GDP to 156% GDP, and is now only 6ppt below the debt ratio of so-called “advanced” of “developed markets” (DM).

For reference, the DM debt ratio has fallen from 174% GDP at the beginning of this period and from its all-time high of 183% GDP in 4Q20.

These dynamics have supported a popular investment narrative called, “The EM-debt story”.

In my previous post, however, I noted that all sectors of the Chinese economy are increasing their levels of indebtedness and that all their debt ratios hit new highs in 2Q23 (see “Whisper it softly – Part III“).

The key point here is that if we strip out China, EM’s shares of global debt has only increased slightly since the GFC, from 10% to 13%.

What this means is that rather than witnessing an EM-debt story, we have, in fact, been witnessing “The China-debt story” since the GFC.

So what?

While the EM classification remains convenient, it is increasingly less relevant and/or helpful in terms of understanding the impact of global debt dynamics on macro policy, investment decisions and financial stability.

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

“Whisper it softly – Part III”

All sectors of the Chinese economy are increasing leverage still, but…

The key chart

Trends in “excess credit growth” in China since June 2013 (Source: BIS; CMMP)

The key message

Whisper it softly (III), but all sectors of the Chinese economy are increasing their levels of indebtedness still.

The Chinese government is the main driver here, rather than the private sector, however. The rate of private sector “excess credit” generation has slowed markedly (see key chart above). With a (private sector) balance sheet recession still a risk (if not a reality yet), these trends can be expected to continue.

According to the latest BIS date release, China’s total, government, household (HH), corporate (NFC) and private sector (PS) debt ratios all hit new highs in 2Q23 (308%, 79%, 62%, 166% and 228% GDP respectively). China now accounts for 23% of total global debt, 26% of global PS debt and 32% of global NFC debt. In June 2009, these shares were only 7%, 8% and 12% respectively.

A key dynamic to note here, however, is the rate of growth in debt or “excess credit” generation. At times, this can be as important, if not more important than the level of debt/indebtedness. The key chart above illustrates the 3Y CAGR in government, HH and NFC debt in relation to the 3Y CAGR in nominal GDP.

Three distinct phases are visible – the first (1) includes the period of excess HH, NFC and government credit growth; the second (2) includes the period of excess HH and government debt, and the third (3 and current phase) includes excess government credit growth but much slower rates of HH and NFC excess credit growth.

At the start of 2023, I posed the question, “what if China’s private sector turns to debt minimisation/savings maximisation instead?” Or, “what if China experiences as balance sheet recession?”

As noted later in September 2023, the “balance sheet recession” story is still on hold, at least for the time being. Although it did become part of the 1H23 investment narrative briefly. Nonetheless, the dynamics of money creation and potential growth are shifting clearly. Credit rating agencies may (mistakenly) wish to see lower levels of government debt in China, but if current dynamics continue it will be fiscal policy/government spending that will have to do the “heavy lifting” if China’s growth is to recover.

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

“Whisper it softly – Part II”

US private sector indebtedness is largely unchanged over the past two decades

The key chart

Trends in US private sector debt ratio (% GDP, RHS) and relative growth versus nominal GDP (3Y CAGR %, LHS) (Source: BIS; CMMP)

The key message

Whisper it softly, but the level of US private sector INDEBTEDNESS is largely unchanged over the past TWO DECADES.

According to the latest BIS data release, the private sector debt ratio was 150% GDP at the end of 2Q23, down from its all-time peak of 170% GDP (3Q08) and its recent “pandemic-peak” of 162% GDP (4Q20). For reference, the debt ratio was 149% GDP at the end of 2Q03 (see key chart above).

The absolute level of debt reached a new high ($39.9tr) in 2Q23, however, re-enforcing the difference between the level of debt and the level of indebtedness. A key distinction that is often overlooked in popular, but flawed, US debt narratives.

Over the past three years, private sector debt has grown at a CAGR of 5.6%. Nominal GDP has grown at a CAGR of 7.6% over the same period. This negative “relative growth factor” is illustrated when the blue shaded area in the key chart above falls below the x-axis.

Note that over the past two decades, private sector debt has fallen from 73% of total US debt to 60% of total US debt. Lower-risk, government debt substituted for higher-risk household debt as the private sector embarked on a period of passive deleveraging post-GFC. The US led the advanced world in this important development.

The household debt ratio has fallen from its 1Q08 peak of 98% GDP to 74% GDP at the end of 2Q23. The corporate sector debt ratio has fallen from its 1Q21 peak of 84% GDP to 77% GDP at the end of 2Q23.

So what?

The US is one of only three advanced economies that has both household and corporate debt ratios BELOW the BIS threshold limits above which debt becomes a constraint on future growth. How often is this part of US debt narratives?

Viewed in this context, and recognising the distinction between the level of debt and the level of indebtedness, the resilience of US consumption and growth in the face of unprecedented monetary tightening becomes less surprising…

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

“Whisper it softly – Part I”

The world has been passively deleveraging since December 2020

Global debt (USD bn, LHS) and debt ratio (% GDP, RHS) since June 2009 (Source: BIS; CMMP)

The key message

The world has been passively deleveraging since December 2020 – i.e. debt has been growing at a slower rate than nominal GDP.

This is in contrast to the impression given by popular narratives (see example WEF quote below) about a world “drowning in unsustainable and/or rising debt”.

“Global debt is borrowing by governments, businesses and people, and it’s at dangerously high levels”

World Economic Forum, October 2023

According to the latest BIS data, the total debt ratio (of all BIS reporting economies) fell to 247% GDP in June 2023, down from 290% GDP in December 2020 (see key chart above).

The absolute level of debt also fell from $231tr in March 2022 to $227tr in June 2023 (i.e. active deleveraging).

Note that:

  • In terms of relative growth, global debt has grown at a CAGR of only 3.4% over the past three years compared with a 6.4% CAGR in nominal GDP
  • The debt ratios of the government, HH and NFC sectors all peaked in December 2020. Since then, the government debt ratio has fallen from 109% GDP to 87% GDP, the HH debt ratio has fallen from 70% GDP to 62% GDP, and the NFC debt ratio has fallen from 110% GDP to 97% GDP
  • In absolute terms, government debt peaked in December 2021 ($85tr) while both HH and NFC debt did not peak until March 2023 ($58tr and $89tr respectively)
  • Of the two private sector debt ratios, only the NFC debt ratio is above the BIS’ threshold limit of 90% GDP
  • The structure of global debt has shifted towards public debt and away from higher-risk HH debt since the GFC. This process has been led by the US (see subsequent posts and “Challenging flawed narratives“)

Given the above, a more accurate summary of global debt dynamics might read:

“Borrowing by governments, businesses and people is growing at a slow pace than nominal GDP as the world continues to de-lever. The structural shift away from relatively higher-risk HH debt towards lower-risk public debt also continues, led by the US. Nonetheless, the risks associated with the level of NFC indebtedness remain elevated, albeit lower than in the recent past.”

Viewed in this context, the relative resilience of consumption and growth in advanced economies in the face of unprecedented monetary tightening might have been less surprising…

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

“Cracking…Part II”

US consumer credit dynamics weaken further in October 2023

The key chart

Trends in monthly flows of US consumer credit (Source: FRED; CMMP)

The key message

“Cracking – part II”, the update – US consumer credit dynamics weaken further in October 2023.

Quarterly US consumer credit flows in 3Q23 ($4bn) were the weakest since 2Q20, and only a very small fraction of the pre-pandemic average quarterly flow of $45bn.

Monthly flow data for October 2023, released yesterday (7 December 2023) suggests that momentum is weakening further at the start of 4Q23.

The three-month moving average of flows fell to $1.7bn in October 2023, down from $4.4bn in September and $4.6bn in August and down from the recent April 2022 peak of $32.9bn. Perhaps more importantly, the latest flows are only a fraction of the pre-pandemic average flow of $14.8bn.

Trends in monthly flows of US consumer credit (Source: FRED; CMMP)

The strength of consumer credit demand between April 2021 and April 2023 (see charts above) helps to explain the resilience of US consumption in the post-COVID period, especially in relation to trends observed in the euro area and the UK.

Flows peaked in April 2022, however, and since then, the 2Q23 flows were revised down and momentum has continued to slow in 3Q23 and into the final quarter of the year.

In short, the message from the US money sector is one of weaker consumer credit dynamics and elevated risks to US consumption and the growth outlook.

Focus on the flows…

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

“This is EXACTLY what we (the ECB) wanted to see…”

…but for the rest of us, the risks are obvious, or at least they should be.

The key chart

Trends in private sector financing flows (Eur bn, 12m cum flow) and nominal NFC and HH borrowing costs (%, RHS) (Source: ECB; CMMP)

The key message

The ECB is celebrating that monetary policy transmission is working and delivering results that are EXACTLY [my emphasis] what they wanted to see. These results include:

  • An increase in the cost of borrowing for EA corporates (5.26%) and households (3.91%) to their highest levels since November 2008 and June 2009 respectively
  • Increases in the cost of borrowing for both sectors (343bp, 194bp) that exceed those achieved during the previous 2005-08 tightening cycle (212bp, 179bp) and that have been delivered in half the time (16 months versus 32 months)
  • The highest real cost of borrowing for EA corporates (2.3%) since April 2016/September 2014
  • A collapse in financing flows to the EA private sector from €764bn a year ago to repayments of €5bn now

The risks that the ECB’s celebrations might be premature are obvious, however, or at least they should be (see key chart above):

  • While monetary policy transmission is working as textbooks suggest, both the pace and scale of current tightening is unprecedented
  • The ECB lacks a specific playbook for such a scenario and EA economies now find themselves in uncharted territory
  • Policy tightening continued even as the EA money sector was indicating increased stresses for banks, HHs and NFCs
  • The end result – a combination of NEGATIVE financing flows, historic high policy rates and elevated costs of borrowing – is unlikely to be sustainable

In short, the ECB may be celebrating but the risks of policy errors remain elevated and continue to mount. The old adage, “be careful what you wish for” springs to mind…

This is exactly what we (the ECB) wanted to see

“What we are seeing is that monetary policy transmission is working. There has been a sharp increase in lending rates and a strong slowdown in loan growth. This is exactly what we wanted to see.”

Isabel Schnabel, ECB Executive Board Member, 1 December 2023

Trends in private sector financing flows (Eur bn, 12m cum flow) and nominal NFC and HH borrowing costs (%, RHS) (Source: ECB; CMMP)

In response to a 1 December 2023 interview question about the risk that the rapid drop in credit demand could exacerbate the downturn in the euro area, ECB Executive Board member, Isabel Schnabel, chose to celebrate the sharp increase in lending rates and the strong slowdown in loan growth instead. She stated that, “This is EXACTLY [my emphasis] what we wanted to see” and suggested that this proved that “monetary policy transmission is working”.

So what exactly are we/they celebrating and is there a risk that monetary policy transmission is working too well?

Trend in composite cost-of-borrowing for EA corporates (%) (Source: ECB; CMMP)

First, the composite costs-of-borrowing (CCOB) for NFCs and HHs have risen to their highest levels since November 2008 and June 2009 respectively. The CCOB for new NFC loans increased to 5.26% in October 2023, up 17bp from the previous month (5.09%). In November 2008, this cost was 5.47% (see chart above).

The CCOB for new loans to HHs for house purchases also increased to 3.91% in October 2023, up 2bp from the previous month (3.89%). This is the highest level since June 2009 (see chart below).

Trend in composite cost-of-borrowing for EA households (%) (Source: ECB; CMMP)

Second, these borrowing costs have increased more than in previous tightening cycles and in half the time. The rapid transmission of policy rates to the cost of borrowing is a key and unprecedented feature of the current ECB tightening cycle (see chart below).

Change in NFC and HH cost of borrowing since tightening began plotted against months since tightening began (Source: ECB; CMMP)

The CCOBs for NFCs and HHs have risen by 343bp and 194bp respectively in the 16 months since June 2022. Over the same time period during the 2005-08 tightening cycle, these borrowing costs rose by 133bp and 106bp respectively (see chart below). The current increases exceed the total increases that occurred during the 32 months of this previous cycle (212bp and 179bp respectively).

Trends in NFC and HH costs of borrowing (%, real terms) (Source: ECB; CMMP)

Third, the cost of NFC borrowing in real terms has reached its highest level since April 2016 and September 2014. The real cost of NFC borrowing has increased to 2.3% (see chart above). For reference, real NFC borrowing costs peaked previously at 3.1% in January 2015 and 3.7% in Juley 2009 (see graph above).

The real cost of HH borrowing has increased to 1.0%, its highest level since December 2020, but remains well below the previous, recent peaks of 3.0% in January 2015 and 4.5% in July 2009.

The collapse in financing flows to the EA private sector (Source: ECB; CMMP)

Fourth, cumulative 12-month financing flows to the private sector fell to NEGATIVE €5bn in October 2023, down from €764bn a year earlier. As noted in “Disappearing private sector financing flows – Part 1”, this represented the second consecutive month of negative financing flows, after the negative €33bn in September.

Trends in private sector financing flows (Eur bn, 12m cum flow) and real NFC and HH borrowing costs (%, RHS) (Source: ECB; CMMP)

The risks that the ECB’s celebrations might be premature are obvious, however, or at least they should be (see key chart above):

  • While monetary policy transmission is working as textbooks suggest, both the pace and scale of current tightening is unprecedented
  • The ECB lacks a specific playbook for such a scenario and EA economies find themselves in uncharted territory
  • Policy tightening continued even as the EA money sector was indicating increasing stresses for banks, HHs and NFCs
  • The end result – the current combination of NEGATIVE financing flows, historic high policy rates and elevated costs of borrowing – is unlikely to be sustainable

In short, the ECB may be celebrating but the risks of policy errors remain elevated and continue to mount. The old adage, “be careful what you wish for” springs to mind…

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