Europe – Page 6 – Chris Mallin Macro Perspectives

“Clues from consumer credit”

What are US, EA and UK consumer credit flows telling us?

The key chart

**Monthly CC flows as a multiple of pre-COVID averages** (Source: FRED; ECB; BoE, CMMP)

The key message

Monthly consumer credit flows tell us a great deal about the relative strength of the US, euro area (EA), and UK economies and the risks associated with future growth.

The immediate response of US, EA and UK households to the pandemic was a consistent one – they all repaid consumer credit (i.e. negative monthly flows). The subsequent responses have been anything but consistent, however.

The US has seen 24 consecutive months of positive monthly consumer credit flows since August 2020. More significantly, these flows have been more than double their pre-COVID average since March 2022. This suggests that the risks to the US growth outlook include the sustainability of current consumer credit demand in the face of rising borrowing costs.

The EA has experienced more volatile monthly flows but the key message here is that monthly flows have yet to recover to their pre-COVID average. In contrast to the US, the risks to EA economic growth lie more in the lack of demand for consumer credit and on-going household uncertainty.

After two periods of consecutive negative monthly flows (March 2020-June 2020 and September 2020-February 2021), the UK has experienced 19 consecutive months of positive consumer credit flows. While the strength of the recovery here has been less than in the US, UK monthly flows have exceeded their pre-COVID levels since April 2022. The less-than-average monthly flow seen in September 2022, however, is a reminder that the risks to the UK economic outlook lie in demand for consumer credit stalling and household uncertainty returning.

Clues from consumer credit

Monthly consumer credit flows tell us a great deal about the relative strength of the US, EA, and UK economies and the risks associated with future growth.

The US

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

In the US, pre-COVID monthly flows averaged $14.9bn. In the early stage of the pandemic, US households repaid consumer credit for three consecutive months between March and May 2020. Monthly flows turned positive in July 2020 before turning negative again in August 2020.

Since then, there have been 24 consecutive positive monthly flows (see chart above). The latest data point for August 2022, indicates that the 3m MVA of these flows was $32.7bn, 2.2x the average pre-COVID flow.

Monthly flows have been more than double the pre-COVID average since March 2022 suggesting that the risks to the US growth outlook lie in the sustainability of consumer credit in the face of rising borrowing.

The euro area

**Trends in EA monthly consumer credit flows** (Source: ECB; CMMP)

In the EA, pre-COVID monthly flows averaged €3.4bn. In the early stage of the pandemic, EA households also repaid consumer credit for three consecutive months between March and May 2020.

Monthly flows turned positive in April 2022 but the subsequent trend has been more volatile than that in the US (see chart above). The latest data point for September 2022 showed a monthly flow of €4.8bn, which was 1.4x the pre-COVID average. The 3m MVA of monthly flows, however, was €2.2bn, only 0.6x the pre-COVID average.

The 3m MVA of monthly flows has yet to recover to pre-pandemic levels suggesting that the risks to EA economic growth lie more in the lack of demand for consumer credit and on-going household uncertainty.

The UK

**Trends in UK monthly consumer credit flows** (Source: BoE; CMMP)

In the UK, pre-COVID monthly flows average £1.2bn. In the early stage of the pandemic, UK households repaid consumer credit for four consecutive months between March and June 2022 and then again for six consecutive months between September 2020 and February 2021.

Since then, there have been 19 consecutive months of positive monthly flows (see chart above). These flows (on a 3m MVA basis) have exceeded pre-COVID flows since April 2022.

The latest data point for September 2022, shows a monthly flow of £0.7bn (0.6x pre-COVID flows) and a 3m MVA of £1.2bn (slightly below pre-COVID flows). A reminder that the risks to the UK economic outlook lie in demand for consumer credit stalling and household uncertainty returning.

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

“Completing the transition”

The end of “pandemic-era” economics

The key chart

**Growth rate in M3 (% YoY) and contribution (ppt) of M1 and private sector credit**
(Source: ECB; CMMP)

The key message

Monetary developments in the euro area (EA) indicate a clear transition away from “pandemic-era” economics.

Growth rates in broad money (M3) recovered during 3Q22 but remained well below pandemic levels. Three important, positive developments lay behind the headline growth figures.

First, the period of heightened uncertainty and subdued demand for credit that reached a peak during the pandemic has ended.
Second, and following on from this, EA money and credit cycles are re-synching with each other as the demand from credit recovers to levels last seen in December 2008.
Third, and perhaps most importantly, the breakdown of private sector credit is shifting back towards increased demand for productive (COCO-based) lending – corporate credit is accelerating while mortgage demand is moderating slowly.

So far, so good.

Rising inflation is outweighing each of these positive developments, unfortunately.

Monetary trends adjusted from inflation, are sending very different and consistently negative messages. Real growth rates in M1, HH credit and NFC credit typically display leading, coincident and lagging relationships with real GDP. Each indicator is falling at an increasing rate.

If historic relationships between these variables continue, this suggests a deceleration in overall economic activity over the next quarters.

Completing the transition

Monetary developments in the euro area (EA) indicate a clear transition away from “pandemic-era” economics.

**Growth rates (% YoY) in broad (M3) and narrow (M1) money**
(Source: ECB; CMMP)

Growth rates in broad money (M3) recovered during 3Q22 but remained well below pandemic levels. M3 rose 6.3% YoY in September, up from 6.1% YoY in August and 5.7% YoY in July. Despite this, broad money growth was 6.2ppt below its 12.5% YoY January 2021 peak (see chart above).

Narrow money (M1), a key component of broad money, rose only 5.6% YoY, however, down from 6.8% YoY in both August and July. Narrow money growth was 10.9ppt below its 16.5% YoY January 2021 peak.

Behind the headline YoY growth figures lie three important, positive developments.

**Growth rate (% YoY) in M3 and contribution (ppt) of ON deposits and other components**
(Source: ECB; CMMP)

First, the period of heightened uncertainty and subdued demand for credit that reached a peak during the pandemic has ended. Recall that the hoarding of cash by HHs and NFCs, largely in the form of overnight deposits at banks, was the main driver of the spike in broad money during the pandemic (see graph above). M3 growth peaked at 12.5% YoY in January 2021. At the same time, M1 and overnight deposits grew 16.5% YoY and 17.1% YoY and contributed 11.3ppt and 10.1ppt to total broad money growth respectively.

With heightened levels of uncertainty, HHs were increasing their forced and precautionary savings. The key point here is that money sitting idly in overnight deposits at banks contributed to neither economic growth nor inflation.

**Growth rate (% YoY) in M3 and contribution (ppt) of private sector credit**
(Source: ECB; CMMP)

Note also, that at the point of maximum M3 growth, private sector credit grew only 4.5% YoY and contributed only 5.4ppt to the 12.5% YoY growth in broad money (see graph above).

Fast forward to September 2022, and private sector credit grew 6.9% YoY in September, up from 6.8% YoY in August and 6.3% YoY in July. At the end of 3Q22, private sector credit contributed 5.4ppt to the total 6.3% YoY growth rate in broad money. This represents a clear break from the monetary dynamics seen during the pandemic (see key chart above).

**Growth rates (% YoY) in M3 and private sector credit**
(Source: ECB; CMMP)

Second, and following on from this, EA money and credit cycles are re-synching with each other as the demand from credit recovers to levels last seen in December 2008.

As noted in “Don’t confuse the messages”, monetary aggregates and their counterparts move together in typical cycles. Money supply indicates how much money is available for use by the private sector. Private sector credit indicates how much the private sector is borrowing.

**Growth rate (% YoY) in private sector credit minus growth rate in M3**
(Source: ECB; CMMP)

The “pandemic-era” relationship between money and credit cycles was far from typical, however. In January 2021, the gap between the YoY growth rate in M3 (12.5% YoY) and private sector credit (4.5% YoY) reached a historic high of 8ppt (see chart above).

During 2021, CMMP analysis focused on this dynamic as one of the three key signals to monitor. In September 2022, private sector credit grew faster (6.9% YoY) than money supply (6.3% YoY) for the fourth consecutive month as money and credit cycles re-synched with each other.

**Trends in the outstanding stock of private sector credit (EUR bn) with breakdown between COCO-based and FIRE-based lending** (Source: ECB; CMMP)

Third, and perhaps most importantly, the breakdown of private sector credit is shifting back towards increased demand for productive (COCO-based) lending – corporate credit is accelerating while mortgage demand is moderating slowly.

Recall that the outstanding stock of loans that support production and income formation in the euro area (COCO-based loans) only recovered to the GFC period peaks in November 2021 (see chart above). Nearly all of the aggregate growth in euro area lending since the GFC has been in the form of less-productive FIRE-based lending (see “Fuelling the FIRE” and “It’s a record of sorts”).

**Growth (% YoY) in PSC and contribution (ppt) of COCO-based and FIRE-based lending**
(Source: ECB; CMMP)

In September 2022, COCO-based and FIRE-based lending both contributed 3.3ppt to the total 6.6% YoY growth in (unadjusted) private sector credit (see graph above). This contrast sharply with the situation a year earlier in September 2021 when COCO-based and FIRE-based lending contributed 0.7ppt and 2.5ppt to the total 3.2% YoY growth rate.

**Growth rates (% YoY) in mortgages and loans to NFCs**
(Source: ECB; CMMP)

Significantly, the growth rate in lending to NFCs (the largest element of COCO-based lending) grew faster (8.0% YoY) and contributed more to total lending (3.1ppt) than mortgage lending (the largest element of FIRE-based lending) which grew 5.1% YoY and contributed 2.1ppt to total lending.

So far, so good.

Rising inflation is outweighing each of these positive developments, unfortunately. Monetary trends adjusted from inflation, are sending very different and consistently negative messages.

**Growth rates (% YoY in real terms) in M1, HH credit and NFC credit**
(Source: ECB; CMMP)

Real growth rates in M1, HH credit and NFC credit typically display leading, coincident and lagging relationships with real GDP. Each indicator is falling at an increasing rate (see chart above). If historic relationships between the variables continue, this suggests a deceleration in overall economic activity over the next quarters.

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

“Still in-synch?”

Are the UK and EA money sectors still sending consistent messages?

The key chart

**Trends in UK and EA broad money** (Source: BOE; ECB, CMMP)

The key message

The messages from the UK and euro area (EA) money sectors were remarkably consistent during the COVID-19 pandemic. Are they still sending consistent messages now?

Growth in broad money rose sharply in both regions during the pandemic, peaking in 1Q21. Growth in narrow money (M1), and overnight deposits with banks within this, was the main driver of broad money growth. UK and EA households (HHs) were increasing savings and delaying consumption – deflationary rather than inflationary forces. Note, in this context, that growth in private sector credit (key assets of banks) did not match the growth in broad money (key ST liabilities of banks). Indeed the gap between money growth and lending growth reached historically high levels in 1Q21. These were atypical money and credit cycles.

Broad money growth has slowed down to pre-pandemic levels now. UK and EA HHs are no longer hoarding cash. The demand for consumer credit has recovered with the largest quarterly flows since the recovery began in 2Q21. Consumer credit demand has returned to pre-pandemic levels in the UK but has still to recover fully in the EA. Growth rates in money supply and private sector credit have also re-aligned as money and credit cycles have re-synched with each other. In the EA, lending growth exceeded money supply growth in June 2022 for the first time since October 2011. The contribution of productive COCO-based lending has also increased in both regions. In the EA, for example, NFC lending grew faster than mortgages in June 2022.

In short, the key signals that I have been following consistently since early 2021 are all sending broadly positive messages for the economic outlook in both the UK and EA. The money sectors are still sending consistent messages, albeit with slightly different areas of emphasis.

The UK is more geared towards a recovery in consumer credit and has benefited from a stronger recovery here. Overall credit growth is slowing in the UK, however. The EA has seen a more promising recovery in lending to NFC and credit growth is still accelerating (in nominal terms).

As highlighted in the previous two posts, rising inflation has overshadowed all of these positive developments in the EA and the UK, however. Credit growth is negative in real terms in both regions, and leading, coincident and lagging monetary indicators are slowing sharply and in a coordinated fashion.

The synchronisation in the messages from the UK and EA money sectors extends to both the good and the bad news. Plenty for optimists and pessimists to debate here…

Still in-synch?

The messages from the UK and euro area (EA) money sectors were remarkably consistent during the COVID-19 pandemic. Are they still sending consistent messages now?

The impact of the COVID-19 pandemic

**The impact of COVID-19 on UK and EA broad money growth** (Source: BoE; ECB; CMMP)

Growth in broad money rose sharply in both regions to peak in 1Q21 (see chart above). In the UK, the YoY growth rate in M4ex rose from 7.5% in March 2020 to a peak of 15.4% in February 2021. In the EA, the growth rate in M3 rose from 7.5% in March 2020 to a peak of 12.5% one month earlier in January 12.5%.

**Narrow money as %age of broad money in the UK and EA** (Source: BoE; ECB; CMMP)

Growth in narrow money (M1), and overnight deposits with banks within this, was the main driver of broad money growth. M1 currently accounts for 69% of UK M3 and 73% of EA M3, up from 48% and 51% respectively a decade earlier. This means that UK and EA households (HHs) were increasing savings and delaying consumption during the pandemic – deflationary rather than inflationary forces.

Put simply, money sitting idly in bank deposits contributes to neither growth nor inflation.

**The gap between UK and EA lending and money supply growth** (Source: BoE; ECB; CMMP)

Note that the growth in broad money (bank’s ST liabilities) was not matched by growth in private sector credit (banks’ assets). Indeed the gap between growth in money and growth in lending reached historic highs in 1Q21. In short, the money and credit cycles had moved out-of-synch with each other, and to a record extent.

The recovery from COVID-19

Broad money growth has slowed down to pre-pandemic levels now (see chart above). In June 2022, growth in M4ex had slowed to 4.4% in the UK and growth in M3 had slowed to 5.7% in the EA. These represent the slowest rates of growth since January 2020 and February 2020 respectively.

**Monthly HH money flows as a multiple of pre-pandemic average flows** (Source: BoE; ECB; CMMP)

HHs are no longer hoarding cash. In the UK, monthly HH money flows fell to £1.5bn in June 2022, 0.3x the average pre-pandemic flow of £4.7bn. In the EA, monthly HH deposit flows fell to €8.5bn, again this is 0.3x the average pre-pandemic flow of €33bn (see chart above).

**Quarterly consumer credit flows** (Source: BoE; ECB; CMMP)

The demand for consumer credit has recovered with the largest quarterly flows since the recovery began in 2Q21. At the peak of the crisis in 2Q20, UK and EA HHs repaid £13.2bn and €12.9bn in consumer credit respectively. More recently, we have seen five consecutive quarters of positive consumer credit flows (see chart above).

Consumer credit demand has returned to pre-pandemic levels in the UK but has still to recover fully in the EA. In the 2Q22, UK consumer credit flows recovered to £4.2bn, above the pre-pandemic average of £3.6bn. EA consumer credit flows also recovered to €7.5bn, but they remain below the pre-pandemic average of €10.8bn.

**Annual growth rates in UK and EA consumer credit** (Source: BoE; ECB; CMMP)

Annual growth rates in consumer credit have also recovered to post-pandemic highs, to 6.5% in the UK and 3.3% in the EA in June 2022. Note the relative gearing of the UK here (see chart above). Consumer credit growth slowed faster and recovered stronger in the UK than in the EA.

**Trends in the gap between UK and EA lending and money supply growth**
(Source: BoE; ECB; CMMP)

Growth rates in money supply and private sector credit have also re-aligned as money and credit cycles have re-synched with each other (see chart above). In the EA, lending growth exceeded money supply growth in June 2022 for the first time since October 2011. In the UK, lending growth still lagged money supply growth by 2.1ppt in June 2022, but this is much narrower than the peak gap of 11.5ppt seen in February 2021.

**Trends in UK and EA bank lending by type** (Source: BoE; ECB; CMMP)

The contribution of productive COCO-based lending has increased in both regions. In the EA, NFC lending grew faster (5.9%) than mortgages (5.3%) in June 2022. Less productive, mortgage lending remains resilient in the EA, but its growth is slowing in the UK (see chart above).

Conclusion

In short, the key signals that I have been following consistently since early 2021 are all sending broadly positive messages for the economic outlook in both the UK and EA. The UK has benefited from a stronger recovery in consumer credit. The EA has seen a more promising recovery in lending to NFC.

As highlighted in the previous two posts, rising inflation has overshadowed all of these positive developments, however (see “Accounting for inflation” and “Accounting for inflation – part 2”). Credit growth is negative in real terms in both the UK and EA, and leading, coincident and lagging monetary indicators are slowing sharply and in a coordinated fashion.

The synchronisation in the messages from the UK and EA money sectors extends to both the good and the bad news. Plenty for optimists and pessimists to debate here…

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

“Accounting for inflation”

Inflation distorts the 2Q22 messages from the money sector

The key chart

**Nominal and real growth rates in EA private sector credit** (Source: ECB; CMMP)

The key message

Rising inflation distorts the 2Q22 messages from the euro area’s (EAs) money sector significantly.

Ignore inflation and the three key signals that I have been following consistently since early 2021 are all sending broadly positive messages for the region’s economic outlook. Monthly household (HH) deposit flows have moderated sharply, reflecting lower levels of uncertainty. The demand for consumer credit has recovered with the largest quarterly flows since the recovery began in 2Q21. Growth rates in money supply and private sector credit have also re-aligned as money and credit cycles have re-synched with each other. Finally, the contribution of productive COCO-based lending has increased, with growth in lending to corporates (NFCs) outstripping mortgage growth in June 2022. So far, so good.

Take inflation into account and the messages are very different, however. Private sector credit (PSC) is slowing in real terms (-2.3% YoY). With the exception of lending to non-monetary financial corporations (8% of total PSC), the growth rates in all forms of PSC are declining in real terms. Furthermore, trends in real M1, real HH credit and real NFC credit are all slowing sharply in a coordinated manner. This matters because these factors typically display leading, coincident and lagging relationships with real GDP.

Plenty of information for optimists and pessimists to debate but with increasing ammunition for the pessimists…

Accounting for inflation

Rising inflation distorts the 2Q22 messages from the euro area’s (EAS) money sector significantly.

The good news

Ignore inflation and the messages are broadly positive for the region’s economic outlook.

**Trends in monthly HH deposit flows** (Source: ECB; CMMP)

Monthly HH deposit flows have moderated sharply, reflecting lower levels of uncertainty. The monthly flow fell to €9bn in June 2022 (see chart above). This is well below the average pre-pandemic flows of €33bn and the peak flow of €78bn in April 2020 when HH uncertainty levels peaked at the height of the pandemic crisis.

**Quarterly trends in HH deposit flows** (Source: ECB; CMMP)

The quarterly HH deposit flow in the 2Q22 was €53bn (see chart above). This compares with average quarterly pre-pandemic flows of €90bn. The message here is the same – HHs in the EA are no longer hoarding cash in the form of bank deposits. This is reflected, in turn, in the slowdown in broad money growth (see below).

**Trends in monthly consumer credit flows** (Source: ECB; CMMP)

The demand for consumer credit has recovered. Monthly consumer credit flows slowed from €2.4bn in April 2022 and €3.3bn in May 2022 to €1.8bn in June 2022 (see chart above). The YoY growth rate of 3.3% was the second highest rate of growth since consumer credit recovered in April 2021, however (after May 2022’s 3.4% YoY).

**Quarterly trends in consumer credit** (Source: ECB; CMMP)

The quarterly flow of consumer credit in 2Q22 of €7bn was the largest quarterly flow since the recovery started in 2Q21. There have now been five consecutive quarters of positive consumer credit flows (see chart above), albeit these flows remain below the pre-pandemic levels.

**Growth trends in broad money (M3) and private sector credit** (Source: ECB; CMMP)

After the recent unprecedented de-synchronisation of money and credit cycles, growth rates in EA money supply and private sector credit have now converged (see chart above).

The YoY growth rate in broad money (M3) fell to 5.7% in June 2022, the slowest rate of growth since February 2020. In contrast, the growth rate in private sector credit rose to 6.1% YoY, the fastest rate of growth since private sector credit growth turned positive in Mach 2015.

Recall that in January 2021, the gap between the growth rate in M3 and the growth rate in private sector credit was 8ppt. In June 2022, private sector credit grew faster than broad money, suggesting that the period of excess liquidity (see green shaded area in graph above) may be ending.

**Trends in PSC and contribution from COCO-based lending** (Source: ECB, CMMP)

The contribution of productive COCO-based lending is also increasing with the growth in lending to corporates (NFCs) outstripping the growth in mortgages. COCO-based lending contributed 2.5ppt to the total (unadjusted) growth rate in private sector credit of 5.8% (see chart above). This compares with a contribution of only 0.6ppt a year earlier.

Less productive FIRE-based lending is still contributing more (3.3ppt) than COCO-based lending to total loan growth, but corporate lending is now growing faster (5.9% YoY) than mortgage lending (5.3% YoY). Corporate and mortgage lending represent the largest segments of COCO-based and FIRE-based lending respectively.

**Growth trends (% YoY, nominal) in mortgages and NFC lending** (Source: ECB; CMMP)

The bad news

Take inflation into account and the messages are very different, however. PSC is growing 6.1% YoY in nominal terms, the fastest rate of growth since January 2009. In real terms, however, PSC is falling -2.3% YoY. With the exception of lending to non-monetary financial corporations (8% of total PSC), the growth rates in all forms of PSC are declining in real terms.

**Growth trends (% YoY, real terms) in M1, HH credit and NFC credit** (Source: ECB; CMMP)

Furthermore, trends in real M1, real HH credit and real NFC credit are all slowing sharply in a coordinated manner. This matters because these factors typically display leading, coincident and lagging relationships with real GDP over time. (See “Look beyond the yield curve” for more details about these indicators)

Conclusion

The three key signals from the money sector that we have been following consistently since early 2021 are all sending broadly positive messages – HHs have stopped hoarding money, they are borrowing more to fund consumption, and money and credit cycles are re-synching. The on-going recovery in productive COCO-based lending is also positive.

Rising inflation is over-taking these positive trends, however. PSC is falling in real terms and traditional leading, coincident and lagging monetary indicators have turned down sharply and in a coordinated fashion. Plenty of ammunition here for pessimists…

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

“Attenzione!”

Time for new solutions to Italy’s structural problems

The key chart

**Trends in private and public sector net lending/borrowing over the past decade**
(Source: ECB; CMMP)

The key message

With the yield on Italian 10Y government bonds rising to 3.37% (+251bp YTD), attention is focusing again on the net borrowing of the Italian government and the government debt ratio (172% GDP).

This is entirely consistent with conventional macroeconomic thinking that continues to ignore private debt while seeing public debt as a problem. It is also mistaken.

A key theme of CMMP analysis is that, “private debt causes crisis – public debt (to some extent) ends them” (Professor Steve Keen, June 2021). Italy, of course, stands out as being one of only four developed market economies that has household (HH) and corporate (NFC) debt ratios well below the maximum threshold levels above which the BIS believes that debt becomes a constraint on future growth.

Not only does Italy not have a private sector debt problem, some of the economy’s key challenges stem from a lack of private sector borrowing and investment, not from too much. Consider:

The Italian private sector has been a consistent (and growing) net lender over the past decade. Instead of borrowing money to invest, HHs and NFCs have been saving/disinvesting. The outstanding stock of NFC debt at end 3Q21 was below the level recorded in 3Q09, for example.
The net savings of the private sector have been running at 1.5-3.0x the size of the net borrowings of the government. Instead of funding the fiscal stimulus required to close Italy’s deflationary gap, un-borrowed private sector savings have leaked out of the economy.
“Austerity” and future fiscal consolidation have not/will not solve either of these fundamental challenges. Domestic sector imbalances leave the Italian economy increasingly reliant of running current account surpluses. The structural challenges of excess savings and insufficient private sector investment remain.

The fact that un-borrowed savings in countries experiencing private sector deleveraging are able to leak into other bond markets, restricting governments from funding stimulus measures, reflects a structural flaw in the Eurozone. In 2012, Richard Koo, the Japanese economist and global expert on balance sheet recessions, proposed applying different risk weights to domestic and foreign government bonds as a partial solution.

Perhaps the time for new and imaginative solutions to Italy’s sector imbalances is at hand, once again…

Attenzione!

**Top 10 government debt ratios, ranked by size** (Source: BIS; CMMP)

With the yield on Italian 10Y government bonds rising to 3.37% (+251bp YTD), attention is focusing once again on the net borrowing of the Italian government and the government debt ratio (which is the third highest in the world at 172% GDP). This is entirely consistent with conventional macroeconomic thinking that continues to ignore private debt while seeing public debt as a problem. It is also mistaken.

**HH and NFC debt ratios for BIS advanced economies** (Source: BIS; CMMP)

A key theme of CMMP analysis is that, “private debt causes crisis – public debt (to some extent) ends them” (Professor Steve Keen, June 2021). Italy, of course, stands out as being one of only four developed market economies that has HH and NFC debt ratios well below the maximum threshold levels above which the BIS believes that debt becomes a constraint on future growth (see chart above).

According to the latest BIS statistics, Italy’s HH and NFC debt ratios are only 44% GDP and 73% GDP respectively. This compares with average debt ratios in the euro area of 61% GDP and 111% GDP (EA in the chart above) and BIS threshold levels of 85% GDP and 90% GDP respectively (red lines in chart above).

Not only does Italy not have a private sector debt problem, some of the economy’s key problems stem from a lack of private sector borrowing and investment, not from too much.

**Net lending of Italy’s private sector over the past decade** (Source: ECB; CMMP)

The Italian private sector been a consistent (and growing) net lender over the past decade (see chart above). Instead of borrowing money to invest, HHs and NFCs have been saving/disinvesting (see chart below). NFC debt of €1,277bn at the end of 3Q21 was below the €1,305bn recorded at the end of 3Q2009, for example. Over the same period, HH debt has increased by only 1.3% CAGR from €660bn to €764bn.

**Trends in HH and NFC debt and debt ratios since 2009** (Source: BIS; CMMP)

The net savings of the private sector have been running at 1.5-3.0x the size of the net borrowings of the government. Instead of funding the fiscal stimulus required to close Italy’s deflationary gap, un-borrowed private sector savings have leaked out of the economy.

**Trend in private sector net lending versus public sector net borrowing** (Source: ECB; CMMP)

“Austerity” and potential future fiscal consolidation have not/will not solve either of these fundamental challenges. Domestic sector imbalances leave the Italian economy increasingly reliant of running current account surpluses with the RoW (see chart below). The structural challenges of excess savings and insufficient private sector investment remain.

**Trends in Italian net sector balances (EURbn)** (Source: ECB; CMMP)

In “The escape from balance sheet recession and the QE trap”, Richard Koo, the Japanese economist and leading authority on balance sheet recessions, highlighted the structural flaw in the Eurozone that allowed un-borrowed savings in countries experiencing private sector deleveraging to flee to other bond markets, preventing domestic governments from issuing debt to fund stimulus measures.

As far back as 2012, Koo proposed applying different risk weights to domestic and foreign government bonds. He suggested that, “The relatively minor regulatory change of attaching different risk weights to holdings of domestic versus foreign government bonds would go a long way toward reducing pro-cyclical and destabilising flows among government bond markets.”

Perhaps the time for new and imaginative solutions to Italy’s sector imbalances is at hand, once again…

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

“Euro area re-synching – part 2”

The implications for asset allocation

The key chart

**The sharp and co-ordinated slowdown in EA money and private sector credit (% YoY, real)**
(Source: ECB; CMMP)

The key message

What are the implications of the re-synching of euro area money and credit cycles for asset allocation and what are the current messages from the money sector telling us?

Growth rates in narrow money (M1) and loans to the private sector display relatively robust relationships with the business cycle over time. M1, household (HH) and corporate (NFC) credit also enjoy leading, coincident and lagging relationships with GDP respectively and can be very useful inputs into asset allocation processes, therefore.

The recovery in money and credit cycles in the post-GFC period broadly followed this stylised pattern. Other macro-factors complicated the wider interpretation of these trends, however. Interest rate effects (initially) and the COVID-19 pandemic (more recently) had a more important impact on narrow money growth than cyclical factors, for example. At the same time, extended periods of private sector deleveraging resulted in HH and NFC credit growth lagging GDP growth for much of the past decade.

That said, the overall message has been clear – while money growth has exceeded GDP growth over the past decade, credit growth has lagged it. The consequences for macro policy choices of this extended dynamic was clear, even before the pandemic hit.

With money and credit cycles re-synching now, inflation is the key challenge in interpreting current messages from the money sector.

Optimists might note that the slowdown in monetary growth reflects a sharp moderation in deflationary money flows into overnight deposits, and will be encouraged by the resilient HH and recovering NFC credit demand (in nominal terms).

In contrast, pessimists might prefer the more traditional approach described above. For them, the very sharp and co-ordinated slowdown in money and credit growth in real terms with be a far more alarming message, especially for those positioned for economic recovery.

Euro area re-synching – part 2

As a macro strategist, economist and global investor, I have always been interested in the relationship between money, credit and business cycles and the implications for asset allocation.

**The recovery in money and credit followed the stylised pattern post-GFC (% YoY, real)**
(Source: ECB; CMMP)

The recovery in money and credit cycles followed this stylised pattern in the post-GFC period (see chart above). Real M1 bottomed in July 2011 (-1.4%) and turned positive in May 2012. Real HH credit bottomed next in September in 2012 (-2.3%) and turned positive in December 2014. Finally, real NFC credit bottomed in June 2013 (-4.6%) and turned positive in November 2015. Other macro-factors complicated the wider interpretation of these trends, however.

**Trends (% YoY) in real GDP and real M1** (Source: ECB; CMMP)

Interest rate effects (initially) and the COVID-19 pandemic (more recently) had a more important impact on narrow money growth than cyclical factors, for example (see chart above).

Interest rate and cyclical effects are typically the main factors affecting trends in narrow money, with the latter being more relevant for asset allocation purposes.

While real M1 continued to exhibit leading indicator qualities, strong demand for overnight deposits (within M1), driven by their increasing low opportunity cost, suggest that interest rate effects had a greater impact than cyclical factors over much of the past decade. The COVID-19 pandemic also resulted in dramatic increases in forced and precautionary savings, again largely in the form of overnight deposits. This compounded the challenges of interpreting these dynamics (see “Don’t confuse the message”).

**Trends (% YoY) in real GDP and real HH credit** (Source: ECB; CMMP)

At the same time, extended periods of private sector deleveraging resulted in HH and NFC credit growth lagging GDP growth for much of the past decade.

The chart above illustrates how real HH credit has enjoyed a broadly coincident relationship with GDP for most of the period. That said, it also shows that the EA HH sector was engaged in an extended period of passive deleveraging between March 2010 and March 2019 with real growth in HH credit lagging real growth in GDP.

Similarly, the chart below illustrates how NFC credit has also enjoyed a broadly lagging relationship with real GDP growth. Again, the analysis and interpretation is challenged by an extended period of NFC deleveraging. Growth in NFC credit lagged behind real GDP growth from December 2009 to May 2016 and to July 2018, in a more sustained fashion.

**Trends (% YoY) in real GDP and real NFC credit** (Source: ECB; CMMP)

**Monthly HH deposit flows as a multiple of pre-pandemic levels** (Source: ECB; CMMP)

With money and credit cycles re-synching now, inflation is the key challenge in interpreting current messages from the money sector. Optimists might note that the slowdown in monetary growth reflects a sharp moderation in deflationary money flows into overnight deposits (see chart above), and will be encouraged by the resilient HH and recovering NFC credit demand, in nominal terms (see chart below).

**Growth trends (% YoY, nominal) in HH and NFC credit** (Source: ECB; CMMP)

In contrast, pessimists might prefer the more traditional approach described above. For them, the very sharp and co-ordinated slowdown in money and credit growth in real terms (see chart below) will be a far more alarming message, especially for those positioned for economic recovery.

**The alarming and coordinate slowdown in real money and credit growth** (Source: ECB; CMMP)

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

“Euro area re-synching – part 1”

EA money and credit cycles are re-synching

The key chart

**YoY growth rates in M3 and private sector credit and trends in excess liquidity**
(Source: ECB; CMMP)

The key message

Growth rates in euro area (EA) money supply and private sector credit continue to converge and re-align. This matters because the de-synchronisation of money and credit cycles over the past decade, which peaked during the COVID-19 pandemic, created major challenges for policy makers, banks and investors alike.

On a positive note, this reflects a combination of slowing (excess) money supply growth and rising demand for private sector credit. Recall that narrow money (M1), and within that overnight deposits, drove the expansion of broad money (M3) during the pandemic. The contribution of productive COCO-based lending is also increasing, led by a recovery in corporate credit. Importantly, COCO-based lending supports both production AND income formation.

That said, less-productive FIRE-based lending continues to be the more important driver of private sector credit in the EA, driven by resilient mortgage demand. FIRE-based lending, which accounts for more than half of the outstanding stock of credit, supports capital gains through higher asset prices but does not lead directly to income generation. This has negative implications for leverage, future growth, financial stability and income inequality.

In short, the message from the money sector here is broadly positive, albeit with the “hidden-risks” that are associated with higher levels of FIRE-based lending. In the second part of this analysis, I analyse money and credit trends in real terms to consider the implications here for the outlook for growth and business-cycle approaches to asset allocation. The conclusions here are less positive…

Euro area re-synching – part 1

Growth rates in EA money supply and private sector credit continue to converge and re-align (see key chart above). This matters because the de-synchronisation of these cycles over the past decade, which peaked during the COVID-19 pandemic, created major challenges for policy makers, banks and investors alike. The effectiveness of monetary policy, the dominant macro policy during this period, diminished dramatically as a result, and banks and investors had to deal with the consequences of excess liquidity for balance sheet management and the (mis-)pricing of both real and financial assets.

**What is driving the re-synching of money and credit cycles?** (Source: ECB; CMMP)

On a positive note, this reflects a combination of slowing (excess) money supply growth and rising demand for private sector credit (see chart above). Broad money (M3) growth has slowed from its January 2021 peak of 12.5% YoY to 6.0% YoY in April 2022. Growth in private sector credit has recovered from its May 2921 low of 2.7% YoY to 5.3% YoY, the highest nominal rate of growth since May 2020. The gap between the two growth rates (the green line in the chart above) has narrowed from 8ppt in January 2021 to 0.7ppt in April 2022, the narrowest gap since November 2018.

**Contribution (ppt) of COCO-based lending to total private sector credit** (Source: ECB; CMMP)

The contribution of productive COCO-based lending is also increasing (see chart above), led by a recovery in corporate credit. COCO-based lending, which includes lending to corporates (NFCs) and household (HH) consumer credit, contributed 1.9ppt towards to total PSC growth of 4.9% YoY in April 2022. This compares with only 0.4ppt to the total PSC growth of 3.0% in August 2021.

Note that COCO-based lending supports both production and income formation. Loans to NFCs are used to finance production, which leads to sales revenues, wages paid, profits realised and economic expansions. So while an increase in NFC debt will increase debt in the economy, it also increases the income required to finance it. Consumer debt also supports productive enterprise since it drives demand for goods and services, helping NFCs to generate sales, profits and wages. It differs from NFC debt to the extent that HHs take on an additional liability since the debt does not generate income.

**Contributions (ppt) of FIRE-based and COCO-based lending to total private sector credit**
(Source: ECB; CMMP)

That said, less-productive FIRE-based lending continues to be the more important driver of private sector credit (see chart above), driven by resilient mortgage demand (see also chart below).

**What’s driving private sector credit demand?** (Source: ECB; CMMP)

FIRE-based lending, which accounts for more than half of the outstanding stock of credit, supports capital gains through higher asset prices but does not lead directly to income generation. Loans to NBFIs are used primarily to finance transactions in financial assets rather than to produce, sell or buy actual output. Such credit may lead to an increase in the price of financial assets but does not lead (directly) to income generation. Mortgage or real estate lending is used to finance transactions in pre-existing assets. It typically generates asset gains as opposed to income (at least directly). As noted in previous posts, the shift towards FIRE-based lending has negative implications for leverage, future growth, financial stability and income inequality.

In short, the message from the money sector here is broadly positive, albeit with the “hidden-risks” that are associated with higher levels of FIRE-based lending.

**YoY real growth trends in M1, household and corporate credit** (Source: ECB; CMMP)

In the second part of this analysis, I analyse money and credit trends in real terms to consider the implications here for the outlook for growth and business-cycle approaches to asset allocation. The conclusions here are less positive…

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

“Sonnez l’alarme – II”

Plus ça change…

The key chart

**Trends in net lending/net borrowing, EURbn, rolling 4Q sum** (Source: ECB)

The key message

Comments made by the Governor of the Banque de France in Paris last week (1) confirm that conventional macro thinking continues to (largely) ignore private debt while seeing public debt as a problem, and (2) suggests that reports of the death of out-dated fiscal rules in the euro area (EA) are premature.

What did he say? The Governor rejected arguments that (1) accommodative monetary policy was responsible for the rise in public debt, and (2) that “because of this high public debt, monetary policy is now unable to raise interest rates sufficiently to combat inflation”. He stressed that central bank independence was “notably designed to prevent any risk of fiscal domination.” The rest of the speech focused on why debt must remain a key issue and the future EA fiscal rules.

From a CMMP analysis perspective, there were three extraordinary features of the speech:

First, in discussing the exceptional (fiscal) response to exceptional circumstances, the Governor ignored the similarly exceptional disinvestment by the French private sector;
Second, and linked to this, he suggested that France “could keep the 3% deficit target, which is as a “useful anchor” and even the 60% debt target”;
Finally, he chose not to refer to the elevated risks associated with the level, growth or affordability of risks associated with French private sector debt, particularly in the corporate (NFC) sector..

Why does this matter? The Governor’s speech follows similar arguments presented earlier this year by the French state auditor. In both cases, the level of public sector debt was viewed as a problem but private sector debt was ignored, confirming a fundamental flaw in conventional macro thinking. The support for out-dated and arbitrarily determined fiscal rules also means that the risks of deficit reductions compounding further private sector deleveraging in the future remain.

Plus ça change, plus c’est la même chose…

Sonnez l’alarme II – the charts that matter

**Trends in French public sector net borrowing (EURbn) since 1999** (Source: ECB)

**Trends in French and German government debt ratios (% GDP) versus fiscal target** (Source: BIS)

**Trends in French private sector net lending (EURbn) since 1999** (Source: ECB)

**The view from a sector balances perspective** (Source: ECB)

**Breakdown (% total) of French credit to the non-financial sector** (Source: BIS)

**Rolling 3-year CAGR in NFC credit versus 3-year CAGR in nominal GDP** (Source: BIS)

**French NFC sector debt ratio versus BIS maximim threshold limit** (Source: BIS)

**French NFC debt service ratio versus LT average since 1999** (Source: BIS)

**EA private and public sector balances,** EURbn (Source: ECB)

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

“A desynchronised decade”

Created challenges for policy makers, banks and investors alike

The key chart

**Lending growth (% YoY) minus money growth for the UK and EA since 2012** (Source: BoE; ECB)

The key message

Money and credit cycles have been desynchronised for much of the past decade, creating major challenges for policy makers, banks and investors alike.

Growth in money supply has also exceeded growth in private sector credit in the euro area and for much of the period in the UK. The effectiveness of monetary policy, the dominant macro policy, has diminished dramatically as a result.

The gap between growth in money supply and private sector credit hit a historic high during the COVID-19 pandemic. More recently, however, these growth rates have converged as the build-up of excess savings has slowed and the demand for credit has recovered (at least in nominal terms).

This means that three key signals from the UK and EA money sectors have turned more positive: monthly HH money flows have fallen back below pre-pandemic levels; quarterly consumer credit flows have been positive since 2Q21 and have returned to pre-pandemic levels in the UK; and the gap between money supply and private sector credit growth has narrowed.

Macro challenges remain, but the message from the UK and EA money sectors is less bearish than consensus investment narratives.

A desynchronised decade

**Growth rates (% YoY) in EA money and lending** (Source: ECB)

**Growth rates (% YoY) in UK money and lending** (Source: BoE)

Money and credit cycles have been desynchronised for much of the past decade. In typical cycles, monetary aggregates and their key counterparties, such as private sector credit, move together. Put simply, money supply indicates how much money is available for use by the private sector. Private sector credit indicates how much the private sector is borrowing. However, the two charts above show the extent to which, and the periods when, UK and EA money and credit cycles have diverged since March 2012.

**EA money flow minus credit flow (rolling quarters) since Mar 2012** (Source: ECB)

Growth in money supply has also exceeded growth in private sector credit in the euro area and for much of the period in the UK. The charts above (EA) and below (UK) illustrate trends in the gap between money and credit flows (rolling quarters) for both regions. The build-up of liquidity in both regions is clear to see. Increases in the supply of money have not been matched by equivalent increases in private sector demand for credit.

**UK money flow minus credit flow (rolling quarters) since Mar 2012** (Source: BoE)

The effectiveness of monetary policy, the dominant macro policy, has diminished dramatically as a result. Broadly speaking, monetary policy is effective if “central bank accommodation increase money and credit for the private sector to use” (Koo, 2015). Not only has credit growth lagged money supply growth, it has also been predominantly the “wrong type of credit” ie, less productive FIRE-based lending. As noted in previous posts, this has hidden risks in terms of leverage, future growth, financial stability and income inequality.

**Loan growth (% YoY) minus money growth** (Source: BoE; ECB)

The gaps between growth in money supply and private sector credit hit historic highs during the COVID-19 pandemic (see chart above). In the UK, loan growth exceeded money growth between August 2018 and December 2019. During the pandemic, however, the gap between money growth (15.4%) and credit growth (3.9%) widened to 11.5ppt in February 2021. In the EA, money growth (4.9%) exceeded credit growth (3.7%) by 1.2ppt at the end of 2019. The gap peaked at 8ppt in January 2021 – money growth of 12.5% versus credit growth of 4.5%.

**More recent YoY growth trends in UK and EA money and lending** (Source: BoE; ECB)

More recently, these growth rates have converged as the build-up of excess savings has slowed and credit demand has recovered (at least in nominal terms). At the end of 1Q22, money growth had slowed to 5.5% YoY in the UK while credit growth had risen to 3.7% YoY, a narrowing of the gap to only 1.8ppt. Similarly, in the EA, money growth at the end of 1Q22 had slowed to 6.3% YoY while credit growth was 4.7% YoY, a gap of 1.6ppt (see chart above).

Conclusion

What does this mean? Three key signals from the UK and EA money sectors have turned more positive: monthly HH money flows have fallen back below pre-pandemic levels; quarterly consumer credit flows have been positive since 2Q21 and have returned to pre-pandemic levels in the UK; and the gap between money supply and private sector credit growth has narrowed.

Macro challenges remain, but the message from the UK and EA money sectors is less bearish than consensus investment narratives.

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

“If confidence is collapsing – part 2”

We might expect HHs to repay consumer credit again

The key chart

**Quarterly flows in UK (£bn) and EA (EURbn) consumer credit** (Source: BoE, ECB)

The key message

If confidence is collapsing, we might reasonably expect households to be repaying consumer credit again. Are they…?

During the COVID-19 pandemic, households (HHs) in the UK and the euro area (EA) repaid consumer credit in four of the five quarters between 1Q20 and 1Q21 (see key chart above). The message from the money sector over this period was that HHs were increasing savings and delaying consumption.

Quarterly consumer credit flows have been positive since 2Q21, however, and have returned to pre-pandemic levels in the UK in 1Q22. Year-on-year growth rates have also recovered to their highest levels since February 2020 and March 2020 in the UK and the EA respectively. Before we get too excited, it is important to note that growth in consumer credit is negative in real terms (and EA HHs repaid €0.4bn of consumer credit in March 2022). So-called “faster indicators” also indicate that HHs in the UK are still delaying their spending on “delayable” good such as clothing and furniture indicating that the sustainability of consumption remains unproven still.

In short, the trends in two of the three key signals from the money sector remain positive, (if not that exciting). HHs in the UK and the EA have stopped hoarding cash and demand for consumer credit has remained positive. The recovery in the UK appears more advanced than in the EA, although current UK spending is concentrated towards work-related and staple items rather than delayable items.

The key message here is that while HH consumption patterns remain relatively subdued they are inconsistent with more extreme investment narratives.

Messages from the money sector were less optimistic than consensus investment narratives in 2H21 and less pessimistic than the current investment narrative now.

A positive for a macro-strategist currently “long cash”?

If confidence is collapsing – part 2

If confidence is collapsing, we might reasonably expect HH to be repaying consumer credit again. During the COVID-19 pandemic, HHs in the UK and the EA repaid consumer credit in four of the five quarters between 1Q20 and 1Q21 (see key chart above). Between 1Q18 and 4Q19, quarterly consumer credit flows averaged £3.6bn and €10.3bn in the UK and EA respectively. At the height of the pandemic (2Q20), UK and EA households repaid £13.2bn and €12.9bn respectively. The message from the money sector over this period was that HHs were increasing savings and delaying consumption.

Quarterly consumer credit flows have been positive since 2Q21, however, and have returned to pre-pandemic levels in the UK in 1Q22 (see chart above). UK consumer credit flows totalled £3.6bn in 1Q22, up from £3.3bn in 4Q21 and exactly in line with the average pre-pandemic quarterly flows. EA consumer credit flows totalled €4.4bn, down from €6.5bn in 4Q21. In contrast to the UK, current EA flows remain well below the pre-pandemic average flows of €10.3bn and EA HHs repaid €0.4bn of consumer credit in March 2022. Recall that in lesson #5 in “Seven lessons from the money sector in 2020”, I argued that,

“the UK is likely to demonstrate a higher gearing to a return to normality than the EA.”

**YoY growth rates in consumer credit in the UK and EA** (Source: BoE; ECB)

Year-on-year growth rates have also recovered to their highest levels since February 2020 and March 2020 in the UK and the EA respectively. In March 2022, UK and EA consumer credit grew 5.2% YoY and 2.5% YoY respectively (see chart above). Note again the relatively high gearing of the UK to a recovery in consumer credit demand. Before we get too excited, however, it is important to note that YoY growth in consumer credit is negative in real terms in both regions.

**Credit and debit card payments on durable goods compared with pre-pandemic levels**
(Source: ONS)

So-called “faster indicators” also indicate that HHs in the UK are still delaying their spending on “delayable” good such as clothing and furniture indicating that the sustainability of consumption remains unproven still. According to the latest ONS data, credit and debit card spending remains 12% below its pre-pandemic level and 51% below its 2021 high (see graph above). This makes delayable spending the weakest segment in current UK spending (see graph below). Overall card spending is just above pre-pandemic highs, reflecting relatively strong “work-related” and “staples” spending. The latter two segments are 24% and 13% above pre-pandemic levels respectively.

**Credit and debit card spending versus pre-pandemic levels broken down by type** (Source: ONS)

Conclusion

The key message here is that while HH consumption patterns remain relatively subdued they are inconsistent with the more extreme investment narratives that have gained popularity recently. Messages from the money sector were less optimistic than consensus investment narratives in 2H21 and less pessimistic than the current investment narrative now. A positive for a macro-strategist currently “long cash”?

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