Month: January 2024

“Money and financing the EA economy, 2023”

Reviewing the impact of unprecedented ECB policy tightening

They key chart

Trends in 12-month cumulative flows (EUR bn) presented in a stylised consolidated balance sheet format (Source: ECB; CMMP)

The key message

CMMP Analysis focuses on the implications of the relationship between the money sector and the real economy for macro policy, strategy, investment decisions and asset allocation. Monetary aggregates provide key insights into this relationship and their dynamics help us to understand the impact of monetary policy on money and the financing of the economy.

This post reviews the impact of unprecedented policy tightening by the ECB on money and financing for the euro area (EA) in 2023: what happened; why it happened; and why it matters.

Money flows fell sharply on a 12-month cumulative basis to only €18bn in 2023, down from €590bn in 2022 and €1,009bn in 2021. This dramatic contraction reflects three key factors – the rising opportunity costs of money, portfolio rebalancing and a collapse in bank lending:

  1. Policy tightening increased the opportunity cost of holding money and triggered a re-allocation of overnight deposits to better-remunerated, other ST deposits. Outflows from narrow money or M1 (currency plus overnight deposits) reached €-965bn, from inflows of €23bn in 2022 and €1,018bn in 2021. Inflows to other ST deposits (M2-M1) reached €824bn, from €484bn in 2022 and outflows of €55bn in 2021. Inflows into “marketable instruments” (M3-M”) rose to €158bn in 2023, from €83bn in 2022 and €46bn in 2021.
  2. The phasing out of net asset purchases and TLTROs incentivised bank bond issuance and encouraged portfolio rebalancing away from deposits to LT bank liabilities. Flows into LT liabilities rose to €345bn in 2023, from €38bn in 2022. Note that the latter do not form part of monetary aggregates, by definition.
  3. Bank lending, the principal source of money creation (deposits) collapsed. Cumulative flows of lending to the private sector fell to only €40bn in 2023 (within total credit of €72bn in table above), from €624bn in 2022 and €476bn in 2021.

The contraction in narrow money during 2023, while dramatic, was neither an indicator of liquidity problems for EA banks nor a reliable indicator of economic activity or future inflation. At least not in itself. It was, instead, an example of how policy “normalisation” leads to re-adjustments in the structure and dynamics of bank balance sheets.

The collapse in financing flows to the private sector was far more serious. The pace of change of policy, policy transmission, and policy response is unprecedented and leaves the ECB and EA households and corporates without a playbook.

Dramatically reduced financing flows, historically high policy rates and increased borrowing costs are an unsustainable combination that suggest that the risk of policy errors remains very high at the start of 2024.

Money and financing the EA economy, 2023

CMMP Analysis considers the impact of the ECB’s unprecedented monetary policy on money and financing of the euro area (EA) economy from the perspective of monetary dynamics.

Recall that monetary aggregates are derived from the liabilities side of the consolidated balance sheet of monetary financial institutions (MFIs). Money is then classified according to its liquidity or degree of “moneyness” e.g. narrow money (M1, the most liquid), intermediate money (M2), and then broad money (M3), in the case of the euro area

The calculation of money supply involves adding these components together – in essence, the sum of currency in circulation plus the outstanding amount of financial instruments that have a high degree of moneyness. The simplest way to think about money, therefore, is as the short-term liabilities of the banking sector (note that longer-term liabilities are excluded from the definition of broad money as they considered portfolio instruments rather than as a means of transacting)

M3 = M1 (currency plus overnight deposits) plus M2-M1 (other ST deposits) plus M3-M2 (marketable instruments)

Money can also be calculated and understood by re-arranging the so-called “counterparts of money”, i.e. all items other than money on both sides of the consolidated balance sheet. Hence M3 in the euro area can also be calculated as:

M3 = credit to EA residents + net external assets – longer term liabilities + other counterparts

What happened in 2023 and why?

The collapse in money flows (EUR bn, 12m cumulative) to the euro area (Source: ECB; CMMP)

Money flows fell sharply on a 12-month cumulative basis to only €18bn in 2023, down from €590bn in 2022 and €1009bn in 2021 (see chart above). This dramatic contraction reflects three key factors – the rising opportunity costs of money, portfolio rebalancing and a collapse in bank lending.

The collapse in money flows (EUR bn, 12m cumulative) from a components perspective (Source: ECB; CMMP)

Policy tightening increased the opportunity cost of holding money and triggered a re-allocation of overnight deposits to better-remunerated, other ST deposits. Outflows from narrow money or M1 (currency plus overnight deposits) reached €-965bn, from inflows of €23bn in 2022 and €1018bn in 2021 (the blue columns above). Inflows to other ST deposits (M2-M1) reached €824bn, from €484bn in 2022 and outflows of €55bn in 2021 (the maroon columns above). Inflows into “marketable instruments” (M3-M”) rose to €158bn in 2023, from €83bn in 2022 and €46bn in 2021 (the green columns above).

Portfolio rebalancing and flows to LT liabilities (EUR bn, 12m cumulative) (Source: ECB; CMMP)

The phasing out of net asset purchases and TLTROs incentivised bank bond issuance and encouraged portfolio rebalancing away from deposits to LT bank liabilities (see chart above). Flows into LT liabilities rose to €345bn in 2023, from €38bn in 2022. Note that the latter do not form part of monetary aggregates, by definition.

The collapse in PS financing flows (EUR bn, 12m cumulative) to the euro area (Source: ECB; CMMP)

Bank lending, the principal source of money creation (deposits) collapsed. Cumulative flows of lending to the private sector fell to only €40bn in 2023 (within total credit of €72bn in table above), from €624bn in 2022 and €476bn in 2021 (see chart above).

Why these trends matter

The contraction in narrow money during 2023, while dramatic, was neither an indicator of liquidity problems for EA banks nor a reliable indicator of economic activity or future inflation. At least not in itself. It was, instead, an example of how policy “normalisation” leads to re-adjustments in the structure and dynamics of bank balance sheets.

The collapse in financing flows to the private sector was far more serious. The pace of change of policy, policy transmission, and policy response is unprecedented and leaves the ECB and EA households and corporates without a playbook.

Dramatically reduced financing flows, historically high policy rates and increased borrowing costs are an unsustainable combination that suggest that the risk of policy errors remains very high at the start of 2024.

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

“UK corporates and house buyers are reading the BoE’s script…”

…even if consumers are not!

The key chart

Trends in cumulative HH and NFC financing flows (12-months, £bn) (Source: BoE; CMMP)

The key message

UK corporates and house buyers are reading the BoE’s script, even if consumers are not.

Cumulative 12-month financing flows to the household (HH) and corporate (NFC) sectors slowed to £8.3bn in November 2023, down from £65.2bn a year earlier (see key chart above).

  • Cumulative 12-month financing flows to the NFC sector have been consistently negative since January 2023
  • In November 2023, they were -£3.2bn compared with £3.2bn a year earlier i.e. corporates repaid debt throughout 2023
  • Note that the average cost of new NFC borrowing has risen by 495bp to 7.0% since the BoE began policy tightening (see chart below).

Trends in the average cost of new mortgages and NFC loans (%) (Source: BoE; CMMP)

  • Cumulative 12-month finance flows to the HH sector fell to £11.5bn in November, down from £61.3bn a year earlier
  • Lending for house purchases (mortgages) was net zero in November
  • The YoY growth rate for net mortgage lending was 0.3%, the lowest growth rate since the BoE’s monthly data series began back in March 1994
  • Note that the average cost of new mortgages has risen 384bp to 5.34% since the start of policy tightening (see chart above).

So what?

Financing flows to the UK private sector are falling sharply and reaching potential choke points for growth and much needed investment.

Beyond the headlines, there is a sharp contrast in terms of the dynamics of borrowing for consumption (resilient), investment (weak), and house purchases (slowing sharply).

While the message from the UK money sector remains relatively positive for on-going consumer demand, it is far more concerning with respect to investment and real estate.

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

“UK consumers are still not reading the BOE’s script”

Monthly consumer credit flows jumped to £2bn in November 2023

The key chart

Monthly flows (£bn) of UK consumer credit since November 2019 (Source: BoE; CMMP)

The key message

UK consumers are still not reading the BoE’s script – at least not fully.

Monthly flows of consumer credit rose to £2.0bn in November 2023 from £1.4bn in October 2023 and £1.5bn in September 2023 (see key chart above). The rise was largely attributable to a £0.5bn increase in borrowing on credit cards from £0.5bn in October 2023 to £1.0bn in November 2023.

The annual growth rate in the stock of consumer credit rose to 8.6% YoY, the highest rate since September 2018.

So what?

The BoE argues that, “higher interest rates make it more expensive for people to borrow money and encourages them to save.” The cost of borrowing has increased and households are saving more too. However, they also continue to borrow to fund consumption – in November the amount was 1.7x the average pre-pandemic flow.

In short, the BoE’s policy appears to resemble a three-legged stool that is missing an important leg…

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

“What next for US consumption?”

Mixed messages from the US money sector at the end of 2023

The key chart

Long term trends in US consumer credit ($bn) (Source: FRED; CMMP)

The key message

The US money sector sent mixed messages about the outlook for consumption and growth at the end of 2023.

The outstanding stock of consumer credit recorded a new “round number” of $5tr in November 2023, albeit it with a (nominal) rate of growth below its long term trend (see key chart).

Monthly flows ($bn) in US consumer credit (Source: FRED; CMMP)

CMMP Analysis has been following the recent slowdown in monthly flows of consumer credit with interest.

November 2023 saw a reversal of this trend, however. The monthly flow of consumer credit jumped to $24bn, from $6bn in October 2023 and $11bn in September 2023. November’s monthly flow also exceeded the pre-pandemic average flow of $15bn for the first time since May 2023 (see chart above).

The 3m MVA of monthly flows rose to $13bn in November 2023 from under $1bn in October 2023 but remained below its pre-pandemic average of $15bn.

So what?

It is dangerous to read too much into one month’s data release but for now, at least, the message from the money sector is that the “cracking US consumer” narrative is currently on hold….

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

“The danger of confusing Canadians and Americans”

Why are Canadian commentators typically more bearish on the outlook for US households?

The key chart

Diverging trends in US and Canadian HH debt service ratios and affordability risks (Source: BIS; CMMP)

The key message

My Canadian friends typically recoil when being mistaken for Americans – and understandably so. They have their own unique nationality, heritage and culture. Despite being close geographical neighbours, they have their own unique experiences too. At the same time, my American friends may recoil when Canadian economic and market commentators allow their own domestic experiences to distort their outlook for US household sector vulnerabilities. Again, understandably so – they each have their own unique experiences.

Confusing Canadians and Americans is rarely a good idea…

For the rest of us the message is clear. Among developed economies, affordability risks are at their highest in Canada, Switzerland, Sweden and France (Lesson #2 from the money sector in 2023). Ignoring key structural shifts in US HH dynamics is a mistake as those who underestimated the resilience of the US consumer found out to their cost last year.

The dangers of confusing Canadians and Americans

Twenty year trends in US and Canadian HH debt ratios (Source: BIS; CMMP)

Note that the US household (HH) debt ratio peaked at 99% GDP back in December 2007 (see chart above). It is now 74% GDP, below the 85% GDP threshold level above which the BIS considers debt to be a constraint on future growth. The Canadian HH debt ratio only peaked 13 years later at 113% GDP in December 2020. It is now 103% GDP, still well above the BIS threshold level.

Twenty year trends in US and Canadian HH RGFs (Source: BIS; CMMP)

The rate of “excess credit growth” (or relative growth factor) – where the 3Y CAGR in debt is above the 3Y CAGR in nominal GDP – peaked in the US at 6.6ppt back in March 2004. In Canada, the rate of excess credit growth did not peak until December 2009 at 7.7ppt. There is one similarity here, however. In both economies, the relative growth factors are currently negative (see chart above).

Diverging trends in US and Canadian HH debt service ratios and affordability risks (Source: BIS; CMMP)

This matters because HH sector vulnerabilities with respect to “affordability risks” are very different in these economies. The HH debt service ratio (DSR) in the US is currently 7.7%. This is 3.9ppt below its historic high of 11.6% and 1.5ppt below its long-term average of 9.2%. In sharp contrast, the HH DSR in Canada is at a record high of 14.4%, 2.1ppt above its long-term average of 12.3%.

Conclusion

Confusing Canadians and Americans is rarely a good idea…

Among developed economies, affordability risks are at their highest in Canada, Switzerland, Sweden and France (Lesson #2 from the money sector in 2023). Ignoring key structural shifts in US HH dynamics is a mistake as those who underestimated the resilience of the US consumer found out to their cost last year.

Happy New Year!

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