The key chart
The key message
If confidence is collapsing, why have household (HH) money flows in the UK and the euro area (EA) fallen back below pre-pandemic levels?
During the COVID-19 pandemic, HHs increased their holdings of liquid assets such as overnight deposits, despite earning negative real returns on those assets. In other words, the expansion of broad money over the period was a reflection of deflationary rather than inflationary forces, challenging the monetarist explanation for the current rise in inflation.
In both the UK and EA, monthly HH money flows have fallen back below pre-pandemic levels during 1Q22. These trends support the argument that forced savings, rather than precautionary savings, were the main driver of the spike in HH savings during the pandemic. This is important because forced savings can be released relatively quickly to support economic activity. Nonetheless, it would also be reasonable to assume that the level of precautionary savings would still be above pre-pandemic levels given the uncertainties caused by the Ukraine war, rising inflation and cost-of-living pressures. So far, at least, this does not seem to be the case…
…is the consensus narrative in relation to consumer confidence becoming too bearish?
If confidence is collapsing
If confidence is collapsing, why have household (HH) money flows in the UK and the euro area (EA) fallen back below pre-pandemic levels? Recall that these flows offer important insights into HH behaviour and were one of three key signals that CMMP analysis focused on throughout 2021 in order to interpret macro trends more effectively. The other signals were trends in consumer credit demand (growth outlook) and the synchronisation of money and credit cycles (policy context). I will turn to these signals in subsequent posts.
During the COVID-19 pandemic, HHs increased their holdings of liquid assets such as overnight deposits despite earning negative real returns (see key chart above). In the UK, monthly money flows peaked at £27bn in May 2020 and again at £21bn in December 2020, 5.8x and 4.5x average pre-pandemic levels of £4.6bn respectively. In the EA, monthly HH deposit flows peaked at €78bn in April 2020, 2.4x the average pre-pandemic level.
This meant that the expansion of broad money over the period was a reflection of deflationary rather than inflationary forces. Narrow money (M1), which comprises notes and coins in circulation and overnight deposits, has been increasingly important component/driver of broad money. In March 2022, M1 represented 68% and 73% of M3 in the UK and EA respectively (see chart above). This compares with respective shares of only 46% and 49% in March 2009. This matters for the simple reason that it challenges the monetarist explanation of rising inflation.
Money sitting idly in overnight deposits with banks contributes to neither growth nor inflation.
In both the UK and EA, monthly HH money flows have fallen back below pre-pandemic levels during 1Q22. In the UK, monthly flows in February and March 2022 were £4.1bn and £4.6bn respectively (see chart above). These compare with the average pre-pandemic flow of £4.7bn. In the EA, March 2022’s monthly flow of €16bn, was half the average pre-pandemic flow of €33bn (see chart below).
These trends support the argument that forced savings, rather than precautionary savings, were the main driver of the spike in HH savings during the pandemic. This is important because forced savings can be released relatively quickly to support economic activity. Nonetheless, it would also be reasonable to assume that the level of precautionary savings would still be above pre-pandemic levels given the uncertainties caused by the Ukraine war, rising inflation and cost-of-living pressures.
So far, at least, this does not seem to be the case…is the consensus narrative too bearish?
Please note that the summary comments above are extracts from more detailed analysis that is available separately.