Why have HH money flows fallen back below pre-pandemic levels?
The key chart
Monthly HH deposit flows as a multiple of average pre-pandemic levels. (Source: BoE; ECB)
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.
Narrow money (M1) as a %age of broad money (M3) (Source: BoE; ECB)
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.
UK monthly HH money flows (£bn) and multiple of pre-pandemic level (x) (Source: BoE)
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).
EA monthly HH money flows (EURObn) and multiple of pre-pandemic level (x) (Source: BoE)
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.
Where are the “real risks” in French debt dynamics?
The key chart
Trends in French debt ($bn) broken down by sector (Source: BIS; CMMP)
The key message
France’s state auditor, the Cour des Comptes, “sounded the alarm” about the impact of pandemic spending on France’s widening budget deficit and rising government debt levels last week. The auditor also raised concerns about potential risks to the cohesion of the EA. Are these concerns justified or do greater risks lie elsewhere within French debt dynamics?
The auditor is correct to highlight the impact of pandemic spending on the government’s net borrowing. This rose from 78bn in 3Q19 to €220bn in 3Q21. The level of government debt and the debt ratio are close to their record 1Q21 highs. The debt ratio has remained above the EA’s 60% GDP threshold for the past two decades and the divergence in the debt ratios of France and Germany in the post-GFC period represents a “potential risk to the cohesion of the EA”.
The first counter argument, based on national accounting principles, is that the correct level of government net borrowing is the one that balances the economy not the budget. The level of private sector net lending rose from €75bn in 3Q19 to €225bn in 3Q21, driven largely by HH net savings of €134bn. In other words, the net borrowing of the government was a necessary, timely and appropriate response to the scale of the private sector’s net lending/disinvestment.
The second counter argument is that that while the outstanding stock of French government debt may be the fourth highest in the world, France ranks lower in terms of government indebtedness. This argument will be more compelling to those who view debt sustainability (correctly) as a flow concept, but much less compelling to those who prefer the traditional stock-based approach.
From a risk and financial stability perspective, we are more concerned about France’s private sector debt dynamics, particularly in the NFC sector. France has relatively high exposure to the NFC sector, the fifth most indebted NFC sector globally. In spite of this, France has seen the third highest rate of excess NFC credit growth globally over the past three years. Affordability risks in the NFC sector are also elevated in absolute terms and in relation to historic trends. While the level of HH indebtedness in France is low in absolute terms, the risks associated with excess HH credit growth and affordability are elevated in this sector too.
The headlines resulting from the Cour des Comptes’ report support our wider hypothesis that conventional macro thinking is flawed to the extent that it typically ignores private debt while seeing government debt as a problem rather than as a solution.
Sonnez l’alarme?
France’s state auditor, the Cour des Comptes, “sounded the alarm” about the impact of pandemic spending on the widening budget deficit and level of government debt in its 2022 Annual Report published on 16 February 2022. The auditor also argued that the government should revise its deficit reduction plans after April’s presidential election, claiming that current plans risk fuelling divergences within the euro area, especially with more fiscally conservative countries such as Germany.
The supporting evidence
Trend in government net borrowing over the past twenty years (Source: ECB; CMMP)
The state auditor is correct to highlight the impact of pandemic spending on the budget deficit. As illustrated in the chart above, the government’s net borrowing rose from €78bn in 3Q19 to €220bn in 3Q21. The current level of net borrowing is also higher than the previous peak net borrowing of €143bn in the aftermath of the GFC. Viewed in isolation, this is a scary chart!
Trends in government debt and debt ratios over the past twenty years (Source: BIS; CMMP)
The level of government debt and the debt ratio are also close to their all-time highs (see chart above). The outstanding stock of government debt rose form €2,727bn in 2Q19 to €3,088bn in 2Q21, slightly below the peak 1Q21 level of €3,099bn. The government debt ratio (the blue line above) rose from 113% GDP in 2Q19 to 128% GDP in 2Q21. Again, the debt ratio also peaked at 134% GDP in 1Q21. Note that throughout the past two decades, France’s government debt ratio has exceeded the EA’s threshold of 60% GDP.
Trends in French and German government debt ratios (Source: BIS; CMMP)
The debt ratios of France and Germany have been on different trajectories for most of the post-GFC period. The German government debt ratio peaked at 86% GDP in 4Q12 and declined to a recent low of 64% GDP in 4Q19 (still above the EA’s threshold level). So again, the auditor is correct to highlight this as a “potential” source of risk to the cohesion of the EA.
The counter arguments
The first counter argument here is a simple one – the correct level of government net borrowing is the one that balances the economy not the budget. It is a basic principle of national accounting that the net borrowing of one economic sector (in this case the French government), must be equal to net lending of one or other economic sector(s) (see “Everyone has one”).
Private sector net lending versus public sector net borrowing (Source: ECB; CMMP)
The chart above plots the net lending of the private sector and the net borrowing of the public sector together. The level of private sector net lending, or disinvestment (the blue area), rose from €75bn in 3Q19 to €225bn in 3Q21, driven largely by HH net savings of €134bn and FI net savings of €125bn.
In other words, the increase in the government’s net borrowing position essentially matched the increase in the private sector’s net lending position. Rather than a source of alarm, the spending response of the French government was necessary, timely and appropriate.
The second counter-argument is that while, the outstanding stock of French government debt may be the fourth highest in the world, France is ranked lower in terms of government indebtedness (with a debt ratio similar to the UK).
Top 10 BIS reporting economies ranked by total government debt (EURbn) (Source: BIS; CMMP)
The chart above ranks the top ten BIS reporting countries in terms of outstanding government debt. Total government debt was $3,670bn at the end of 2Q21, representing a 4% share of global government debt after the US (33%), Japan (14%) and the UK (5%). The chart below ranks the top ten BIS reporting countries in terms of the government debt ratio. In this case, France’s ranking drops to #8 globally and #7 in Europe after Greece, Italy, Portugal, Spain, Belgium and the UK.
Top 10 BIS reporting economies ranked by government debt ratio (% GDP) (Source: BIS; CMMP)
This second counter-argument will be less persuasive for those who view debt sustainability as a stock concept (the traditional approach). They will point to the fact that France’s government debt ratio is not only above the EA average, but it is also above the (largely arbitrarily chosen) 60% or 90% thresholds. CMMP analysis, which is centred on the sector balances framework, considers both fiscal space and debt sustainability as flow concepts and for reasons mentioned above (and possibly in future posts) is less concerned here.
What about private sector debt dynamics?
From a risk and financial stability perspective, we are more concerned about France’s private sector debt dynamics, particularly in the NFC sector.
Trends in the breakdown of French and EA debt (Source: BIS; CMMP)
France has a relatively high exposure to NFC debt. At the end of 2Q21, NFC debt accounted for 46% of total debt. This is down from 50% at the time of the GFC (see chart above) but remains above the aggregate shares of 32% and 39% for advanced and EA economies respectively. Why does this matter?
Top 10 BIS reporting economies ranked by NFC debt ratio (% GDP) (Source: BIS; CMMP)
France’s NFC sector is the fifth most indebted NFC sector among BIS economies. At the end of 2Q21, the NFC debt ratio was 170% GDP, after Luxembourg (322%), Hong Kong (304%), Sweden (179%) and Ireland (171%). The French NFC debt ratio is well above the 111% GDP and 98% GDP aggregate for all advanced and EA economies respectively and the 90% threshold level above which the BIS considers debt to be a drag on future growth.
In spite of the high level of NFC indebtedness, France has seen the third highest levels of excess NFC credit growth over the past three years (see chart above). The NFC sector’s RGF was 4.8% in 2Q21, after Switzerland (6.7%) and Japan (6.6%). The rate of excess NFC credit growth was well above the EA average of 1.8% and higher than the 3.0% average for all advanced economies. Risks are clearly elevated when excess rates of credit growth combine with high levels of indebtedness, as is the case here (for an explanation of the RGF framework see here.)
Trends in NFC debt service ratio (Source: BIS; CMMP)
The NFC debt service ratio (DSR) is also high in absolute terms and above its respective LT average despite the low absolute cost of NFC borrowing. As at the end of 2Q21, the DSR was 60%, 9ppt above its LT average of 51% (see chart above). France is one of four advanced economies where the DSRs are high in both absolute terms and in relation to LT averages, along with Sweden, Canada, and Norway (see chart below).
NFC debt service ratios and deviations from LT averages (Source: BIS; CMMP)
While the level of HH indebtedness in France is low in absolute and relative terms, the risks associated with excess HH credit growth and affordability are elevated in this sector too. At the end of 2Q21, the HH debt ratio was 67% GDP, slightly below the 4Q20 peak level of 68%. The HH debt ratio is higher than the 61% EA average but below the 77% advanced average and the BIS threshold level of 85% GDP. Nonetheless, France has the seen the highest rate of excess HH credit growth over the past three years among EA and other advanced economies. The HH’s debt service ratio, while low in absolute terms, is also above its LT average (see “Global debt dynamics – IV” for more details and charts).
Conclusion
The COVID-19 pandemic had a significant impact on the French government’s net borrowing and the level of government debt. The widening gap between France’s government debt ratio and those of the so-called “fiscally-conservative” economies is also a potential source of conflict with the EA. Viewed from a sector balances perspective, however, the government’s response was timely, necessary and appropriate. We are also more concerned about the risks associated with private sector debt dynamics, particularly in the highly indebted NFC sector.
More fundamentally, the headlines resulting from the Cour des Comptes’ report support our wider hypothesis that conventional macro thinking is flawed to the extent that it typically ignores private debt while seeing government debt as a problem rather than as a solution.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
UK and euro area (EA) money sectors have sent remarkably consistent messages throughout the COVID-pandemic. Shared trends in monetary aggregates, for example, provided similar conclusions regarding household (HH) behaviour, consumption and growth, the challenges facing policy makers, and the productivity of lending to the private sector (PSC).
The 4Q21 proved to be an important inflexion point in terms of HH confidence and behaviour in both regions. By December 2021, monthly deposit flows had moderated to 0.6x and 0.7x their pre-pandemic levels in the UK and EA respectively, leaving excess savings of c£162bn and c€285bn in the form of bank deposits. Demand for consumer credit recovered to 1.4% YoY and 1.2% YoY in the UK and EA respectively, and quarterly flows were positive in each of the past three quarters. So far, so good.
In addition to rising inflation, the Bank of England and the ECB both face on-going challenges in terms of the persistent desychronisation of money and credit cycles, which limits monetary policy effectiveness, and the fact that policy responses to date have fuelled growth in the wrong type of credit. The gap between the growth in money supply (ST liabilities of banks) and growth in PSC (key assets of banks) has narrowed but remains wide by historic standards. Nonetheless, the build-up of excess liquidity in both regions is slowing. Mortgage lending, the largest element of so-called “FIRE-based” lending, continues to be the main driver of PSC in the UK and the EA. This has potentially negative implications for growth, leverage, income inequality and financial stability.
In short, the money sectors in the UK and EA continue to sing from the same song sheet. The message for corporates, policy makers and investors alike is that an important inflexion point was reached in terms of HH confidence and behaviour in 4Q21. This is welcome news.
Of course, policy challenges remain and a slowdown in excess liquidity and/or a diversion into productive COCO-based lending rather than less productive FIRE-based lending may be less welcome news for financial assets in 2022.
The money sectors in the UK and the euro area (EA) have sent remarkably consistent messages throughout the COVID-19 pandemic. We know that narrow money (M1), and overnight deposits within M1, drove the expansion of broad money (M4ex, M3 respectively) in both regions during 2020, for example. In other words, the rise in broad money illustrated in the chart above was a reflection of the deflationary forces of increased savings and delayed consumption.
We also know that, as at the end of December 2021, M1 represented 68% and 73% of M3 in the UK and the EA, up from 48% and 51% respectively a decade earlier (see chart below). Preference for highly liquid assets remains high, despite the negative real returns earned from those assets.
Narrow money as a share of broad money since December 2011 (Source: BoE; ECB; CMMP)
A sustained recovery in both regions required/requires a reversal of these deflationary trends ie, a moderation in monthly HH deposit flows and a recovery in consumer credit (see “Three key charts for 2021”). Central banks also need to see a resynching of money and credit cycles. Why? Because, monetary policy effectiveness is based on certain stable relationships between monetary aggregates.
Monthly HH deposit flows as a multiple (x) of pre-pandemic levels (Source: BoE; ECB; CMMP)
As noted in “Missing the point?” in December 2021, HH behaviour reached a potentially important inflexion point at the start of the 4Q21. Monthly deposit flows (see chart above) peaked at 5.9x pre-pandemic levels in the UK in May 2020 and 2.4x pre-pandemic levels in the EA in April 2020. In December 2021, these flows had moderated to 0.6x and 0.7x pre-pandemic levels respectively. During this process HHs have accumulated excess savings in the form of bank deposits of £162bn in the UK and €285bn in the EA (CMMP estimates).
Annual growth rates in consumer credit reached a low point in February 2021 in both the UK (-10% YoY) and the EA (-3% YoY). In December 2021, however, annual growth rates had recovered to 1.4% YoY and 1.2% YoY respectively in the UK and EA respectively (see chart above). More importantly perhaps, quarterly flows of consumer credit have been positive and rising for the past three quarters (see chart below). The 4Q21 flows of £3bn and €4bn in the UK and EA respectively remain below pre-pandemic levels, however, especially in the EA where quarterly flows averaged €10bn during 2018-2019.
Quarterly flows in consumer credit (£bn, EURO bn) (Source: BoE; ECB; CMMP)
The COVID-19 pandemic exacerbated the desynchronisation of money and credit cycles in the UK and EA creating major challenges for policy makers, banks and investors alike. The degree of this desynchronisation peaked in early 2021 and reached its narrowest level since early 2020 in December 2021 (see chart below). That said, the gap between the growth rates of money supply (short-term liabilities of banks) and private sector lending (the main asset of banks) persists and remains high in a historic context.
Growth in lending (% YoY) minus growth in money supply (% YoY) (Source: BoE; ECB; CMMP)
Mortgage lending, the largest element of so-called “FIRE-based lending”, continues to be the main driver of PSC growth in both regions (see chart below). In December 2021, mortgage lending grew 5.1% YoY in the UK and 5.4% YoY in the EA. Lending to NFCs, the largest element of more productive “COCO-based lending”, rose 4.2% YoY in the EA but fell -0.4% YoY in the UK. As described above, consumer credit, another form of COCO-based lending grew 1.4% YoY and 1.2% YoY in the UK and EA respectively.
Breakdown on PSC growth by type of lending (% YoY) (Source: BoE; ECB; CMMP)
Conclusion
The money sectors in the UK and EA continue to sing from the same song sheet. The message for corporates, policy makers and investors alike is that an important inflexion point was reached in terms of HH confidence and behaviour in 4Q21. This is welcome news. Of course, policy challenges remain and a slowdown in excess liquidity and/or a diversion into productive COCO-based lending rather than less productive FIRE-based lending may be less welcome news for financial assets in 2022.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
HH behaviour is normalising but policy challenges remain in the euro area
The key chart
Monetary developments in the euro area since 1999 (Source: ECB; CMMP)
The key message
Broad money growth in the euro area (EA) slowed to 6.9% in December 2021, the slowest rate of growth since February 2020. What is the main driver here and what are the messages for household behaviour, growth, macro policy and the productiveness of lending?
Narrow money (9.8% YoY) continues to be the main driver of broad money growth, contributing 7ppt to the overall 6.9% growth. Overnight deposits (10.1% YoY) contributed 6.2ppt alone. Note (again) that money sitting idly in overnight deposits contributes to neither growth nor inflation. Explanations for rising inflation lie elsewhere.
The on-going moderation in monthly household (HH) deposit flows indicates reduced uncertainty and a normalisation of behaviour. While these flows rose from €17bn in November 2021 to €23bn in December 2021, they remain below the pre-pandemic average of €33bn.
HHs repaid €3.3bn in consumer credit in December 2021, the first net repayments since April 2021. That said, positive quarterly flows of consumer credit of €2bn, €4bn and €b4bn in 2Q21, 3Q21 and 4Q21 respectively also point to a steady normalisation in HH behaviour.
Money and credit cycles remain out-of-synch with each other, presenting an on-going challenge to policy makers. The degree of de-synchronisation reached its narrowest level since March 2020, however, an indication that the build-up of excess liquidity in the EA is slowing.
The additional challenge for policy makers is that less productive FIRE-based lending continues to be the main driver of PSC. This re-enforces the need for macroprudential polices to address rising financial stability risks in the residential real estate (RRE) sector.
In short, the message from the money sector at the end of 2021 and the start of 2022 is mixed. HH behaviour is normalising with deposit flows moderating and demand for consumer credit recovering. Against this, policy makers face the dual challenge of de-synchronised money and credit cycles and excess growth in less-productive FIRE-based lending. Four key signals to watch in 2022…
Slow and steady as she goes
Long-term trends in EA broad money (% YoY) (Source: ECB; CMMP)
Broad money (M3) growth in the euro area (EA) slowed from 7.4% YoY in November 2021 to 6.9% YoY in December 2022, the slowest rate of growth since February 2021 (see chart above). This post examines the current drivers of broad money growth and the implications for household behaviour, growth, macro policy and the productivity of lending in the EA.
Twenty year trends in M3 (% YoY) and contribution (ppt) from M1 (Source: ECB; CMMP)
Narrow money (M1) continues to be the key driver of broad money growth in the EA. M1 grew 9.8% YoY in December 2021 and contributed 7.0ppt to the overall 6.9% growth in broad money alone (see chart above). Within M1, overnight deposits grew 10.1% YoY and contributed 6.2ppt to M3 growth while currency in circulation grew 7.7% YoY and contributed 0.7ppt to M3 growth.
The key point here is that growth in overnight deposits has been the main driver of broad money growth during the COVID-19 pandemic. This matters because money sitting idly in bank deposits contributes to neither growth nor inflation. The causes of rising inflation lie elsewhere.
Trends in monthly HH deposits (EURbn) since January 2019 (Source: ECB; CMMP)
The on-going moderation in monthly household (HH) deposit flows indicates reduced uncertainty and a normalisation of HH behaviour. The sharp rise seen during Phase 2 of the pandemic (see chart above) was driven by a combination of forced and precautionary HH savings – that is, money that was not spent. At their peak of €78bn in April 2020, monthly flows were almost 2.5x their pre-pandemic levels.
In December 2021, monthly flows had fallen back to €23bn, up from €17bn in November 2021, but below the pre-pandemic average level of €33bn. Similarly, HH deposit flows for the 4Q21 were €59bn, down from €109bn and €93bn in the 3Q21 and 2Q21 respectively and below the average €99bn quarterly flows recorded during 2019.
Monthly flows (EUR bn) and growth rates (% YoY) in consumer credit (Source: ECB; CMMP)
HHs repaid €3.3bn in consumer credit in December 2021. This was the first net repayment since April 2021 (see chart above). That said, quarterly flows of consumer credit €2bn, €4bn and €b4bn in 2Q21, 3Q21 and 4Q21 respectively (see chart below) also point to a normalisation in HH behaviour.
Quarterly flows (EUR bn) in consumer credit (Source: ECB; CMMP)Trends in money and credit cycles in the euro area (Source: ECB; CMMP)
Money and credit cycles remain out-of-synch with each other, presenting an on-going challenge to policy makers. The gap between the YoY growth rate of PSC (4.7%) and the YoY growth rate in M3 (6.9%) was -2.8ppt in December 2021 (see chart above). While the degree of de-synchronisation has reached its narrowest level since March 2020, the challenge for policy makers remains since, “monetary policy effectiveness is based on certain stable relationships between monetary aggregates” (Richard Koo, The Holy Grail of Macroeconomics).
Trends in PSC (% YoY) in nominal and real terms (Source: ECB; CMMP)
Private sector credit (PSC) grew 3.9% YoY in nominal terms in December 2021 but fell -1.0% YoY in real terms (see chart above). The additional challenge for policy makers is that less productive FIRE-based lending continues to be the main driver of EA credit. FIRE-based lending contributed 2.5ppt to the overall 3.9% YoY growth rate in PSC in December 2022 (see chart below). Mortgages alone contributed 2.1ppt to this, re-enforcing the need for macroprudential polices to address rising financial stability risks in the residential real estate sector.
Trends in PSC (% YoY) and breakdown (ppt) between FIRE-based and COCO-based lending (Source: ECB; CMMP)
On a final positive note, the contribution of more productive COCO-based lending to overall PSC growth hit its highest level since March 2021 (see chart below), but all forms of COCO-based lending declined YoY in real terms.
Trends in PSC (% YoY) and contribution (ppt) of COCO-based lending (Source: ECB; CMMP)
Conclusion
In conclusion, the message from the money sector at the end of 2021 and the start of 2022 is mixed. HH behaviour is normalising with deposit flows moderating and demand for consumer credit recovering. Against this, policy makers face the dual, on-going challenge of de-synchronised money and credit cycles and excess growth in less-productive FIRE-based lending. Four key signals for 2022…
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Trends in EA COCO-based lending in EURO bn (Source: ECB; CMMP)
The key message
The outstanding stock of loans that support production and income formation in the euro area (“COCO-based loans”) hit a record high in November 2021 of €5,524bn. Is this cause for celebration? No, not quite…
Remarkably, this new high occurred 155 months after the previous high, recorded back in January 2009 (€5,5517bn). Equally notable/concerning is the fact that the stock of less-productive loans that support capital gains through higher asset prices (“FIRE-based loans”) also hit a new record high of €6,091bn. This was €1,503bn above the corresponding January 2009 level of €4,588bn.
What this means is that nearly all of the aggregate growth in euro area lending since the GFC has been in the form of less-productive lending (that also now accounts for more than half of total outstanding loans). So not only is current lending relatively subdued in volume terms (and negative in real terms) it is also largely the wrong type. FIRE-based lending accounted for 2.7ppt of the total 3.7% growth in private sector lending in November 2021, for example.
Over the past two years, I have been highlighting the associated, “hidden risks” associated with unorthodox monetary policy and the negative implications they have for future growth, leverage, financial stability and income inequality. More recently, I also noted that the ECB has (finally) called for (macroprudential policy) measures to address them with specific reference to “real estate risk” at the end of the year.
It is too early to expect changes in the next few data releases (starting this week on 28 January 2022) but I will be placing added emphasis on the trends in the mix of EA lending during 2022. Three key signals became four…
“It’s a record – (of sorts)”
Trends in EA COCO-based lending in EURO bn (Source: ECB; CMMP)
The outstanding stock of loans that support production and income formation (COCO-based loans) hit a record high of €5,524bn in November 2021. Remarkably, this new high occurred 155 months after the previous high recorded in January 2009 (see chart above).
Trends in, and breakdown of, EA private sector credit in EUR bn (Source: ECB; CMMP)
The outstanding stock of loans that support capital gains through higher asset prices (FIRE-based loans) also hit a new high of €6,091bn in November 2021, €1,503bn above the level recorded in January 2009 (see chart above). FIRE-based lending currently accounts for 52% of total euro area lending.
Trends in YoY growth rates in private sector lending in nominal and real terms (Source: ECB; CMMP)
Current lending in the euro area is characterised by relatively subdued volumes and the wrong mix when compared to the pre-GFC period. In November 2006, for example (see graph above), lending to the private sector was growing at 11.2% YoY in nominal terms and 9.2% YoY in real terms. Productive, COCO-based lending accounted for 6.2ppt of this growth, while less-productive FIRE-based lending accounted for 5.0ppt.
Drivers of recent YoY growth rates in EA private sector lending (Source: ECB; CMMP)
In contrast, according to the latest data point for November 2021, lending to private sector grew only 3.7% YoY in nominal terms but fell -1.1% in real terms. Less-productive lending accounted for 2.7ppt of the total 3.7% growth (see chart above).
Longer term drivers of EA private sector lending (Source: ECB; CMMP)
As discussed in previous posts, QE has simply fuelled the shift away from COCO-based lending towards FIRE-based lending in the euro area. This trend has negative implications for future growth, leverage, financial stability and income inequality. Hence, the ECB’s calls in November last year for measures to mitigate risks from FIRE-based lending were welcome. Germany stands out in this context, given the combination of house price dynamics, the extent of house price overvaluation and the lack of specific macroprudential measures to address these risks.
Conclusion
Throughout 2021, CMMP analysis focused on three key signals from the money sector: monthly HH deposit flows (behaviour proxy); trends in consumer credit (growth proxy); and the level of synchronisation of money and credit cycles (policy proxy). These remain important indicators in 2022 to which I will add a key focus on the mix of lending and the potential impact on any new macroprudential measures. Watch this space…
What have the “messages from the money sector” taught us?
Visual summary of the CMMP framework linking all economic sectors together (Source: CMMP)
The key message
Over the past twelve months, the “messages from the money sectors” have taught us more about:
The true value in analysing global banks
How to improve our understanding of global debt dynamics
What does (and does not) constitute a pragmatic and responsible fiscal outcome
Why official forecasts for UK government spending remain flawed
How QE fuelled the “wrong type of lending” and what the ECB thinks should be done about it
How to avoid misinterpreting trends in monetary aggregates
How the behaviour of UK and euro area households reached an important inflexion point at the start of 4Q21
Unfortunately, there is a risk that the renewed rise in COVID-19 cases and emergence of the omicron variant may have masked the final lesson over the Christmas period.
Nonetheless, a final positive message from 2021 is that firmer economic foundations (and higher levels of vaccinations) suggest that both the UK and euro area regions are in a stronger position to face renewed COVID-related challenges now than they were at the start of the year.
Seven key lessons from 2021
Lesson #1: where is the true value in analysing banks?
The true value in analysing global banks comes from understanding the implications of the relationship between the money sector and the wider economy for macro policy, corporate strategy, investment decisions and asset allocations.
A quantifiable and objective framework linking all domestic economic sectors with each other and the rest of the world (see key chart above)
A deep understanding of global debt dynamics (see lesson #2 below)
Unique insights into the impact of global money, credit and business cycles on corporate strategy and asset allocation
Lesson #2: how can we improve our understanding of global debt dynamics?
Household and government debt as a share (% total) of global debt (Source: BIS; CMMP)
Our understanding of global debt dynamics is improved significantly, at the macro level, by extending analysis beyond the level of debt to include its structure, growth and affordability and, at the micro level, by distinguishing between productive (COCO-based) and non-productive sources of debt (FIRE-based), at the micro level (see lesson #5 below).
A great deal of attention focused on the fact that global debt levels hit new highs during 2021. Much less attention focused on the key structural changes that have taken place in the structure of global debt since the GFC:
There has been an important shift away from household (HH) debt towards government debt at the aggregate, global level (see chart above)
Advanced economy dynamics have driven this structural shift, especially in the US and UK
In contrast, the structure of EM debt remains broadly unchanged, with a bias towards private sector debt
I will explore the implications of these (and other structural changes) in my first post in 2022.
Lesson #3: what constitutes a pragmatic and responsible fiscal outcome?
UK financial sector balances (4Q rolling averages, £bn) (Source: ONS; CMMP)
“Pragmatic” and “responsible” fiscal outcomes are those that deliver a balanced economy not a balanced budget.
The three key sectors in any modern economy – the domestic private sector, the domestic government and the RoW – each generate income and savings flows over a given period. If a sector spends less than it earns it creates a surplus. Conversely, if it spends more than it earns it creates a deficit.
Extending fundamental accounting principles, we know that any deficit run by one or more economic sectors must equal surpluses run by other sector(s). This leads to the key identity pioneered by the late Wynne Godley:
Domestic private balance + domestic government balance + foreign balance (must) = zero
UK private and public sector net savings/borrowings as %age of GDP (Source: OBR; CMMP)
Contrary to popular political rhetoric, budget outcomes are inappropriate goals in themselves. Worse still, fiscal surpluses reduce the wealth and financial savings of the non-government sectors.
The good news during the pandemic was that the unprecedented shifts in net savings of the private sector were matched by equally unprecedented shifts in the net deficits of the public sector (see chart above for the UK experience). In other words, policy responses were both timely and appropriate. The risk looking forward is that policy makers ignore these lessons and repeat the mistakes of the post-GFC period (see also lesson #4).
Lesson #4: where are the flaws in offical UK forecasts
Historic and forecast UK sectoral net lending – % GDP, rolling annual average (Source: OBR; CMMP)
Forecast improvements in UK government finances from the OBR rely on dynamic adjustments by other economic sectors and unusual patterns of behaviour beyond that. The assumed end-result is one where sustained, twin domestic deficits are counterbalanced by significant and persistent current account deficits (see chart above).
The OBR described this as a “return to more normal levels.” CMMP analysis suggest it is anything but. Viewed from a sector balances perspective, the risks appear tilted to the downside ie, government finances may not recover as quickly as forecast.
Lesson #5: has QE fuelled the wrong type of lending?
Contribution (ppt) of COCO-based and FIRE-based lending to growth (% YoY) in total lending in the euro area (Source: ECB; CMMP)
Unorthodox monetary policy has fuelled growth in the wrong type of lending. There has been a shift away from productive COCO-based lending towards less-productive FIRE-based lending. The stock of productive lending in the euro area, for example, only returned to its previous January 2009 peak last month (November 2021).
Outstanding stock (EUR bn) of productive COCO-based lending in the euro area (Source: ECB; CMMP)
In other words, the aggregate growth in lending since then has come exclusively from non-productive FIRE-based lending. According to the latest ECB data, for example, FIRE-based lending accounted for 2.7ppt of the total 3.7% YoY growth in private sector lending in November 2021 (see chart below).
What’s driving private sector lending in the euro area? (Source: ECB; CMMP)
In its latest, “Financial Stability Review” (November 2021), the ECB calls for a policy shift away from short-term measures towards “mitigating risks from higher medium-term financial stability vulnerabilities, in particular emerging cyclical and real estate risks”.
This is a welcome development given the negative implications that the rise in FIRE-based lending has for future growth, leverage, financial stability and income inequality. Within the EA, Germany stands out given current house price and lending dynamics, the extent of RRE overvaluation and the absence of targeted macroprudential measures.
Lesson #6: how can we avoid misinterpreting monetary aggregates?
Growth in euro area M3 (% YoY) and contribution (ppt) from M1 and private sector lending (Source: ECB; CMMP)
Trends in monetary aggregates provide important insights into the interaction between the money sector and the wider economy but headline YoY growth figures can be easily misinterpreted, leading to false narratives regarding their implications.
The message from rapid broad money growth in the pre-GFC period, for example, was one of (over-) confidence and excess credit demand. In contrast, the message from rapid broad money growth during the COVID-19 pandemic was one of elevated uncertainty and subdued credit demand (see chart above). Very different drivers with very different implications…
CMMP analysis has focused on three key signals throughout 2021 to help to interpret recent trends more effectively: monthly household deposit flows (behaviour); trends in consumer credit demand (growth outlook) and the synchronisation of money and credit cycles (policy context).
Lesson #7: has HH behaviour in the UK and EA reached an inflexion point?
Monthly HH money flows as a multiple of pre-pandemic levels (Source: BoE; ECB; CMMP)
The behaviour of UK and euro area households reached a potentially important inflexion point at the start of 4Q21. Monthly money flows moderated sharply (see chart above) while monthly consumer credit flows hit new YTD highs ie, positive developments in two of the three key signals.
The recent rise in COVID-19 cases, the emergence of the omicron variant and renewed restrictions imposed by governments may result in these points being missed or, worse, still, reversed.
That said, and to finish on a positive note, firmer economic foundations (and higher levels of vaccinations) suggest that both the UK and euro area regions are in a stronger position to face renewed COVID challenges than they were at the start of the year.
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 extracts from more detailed analysis that is available separately.
Monthly HH money flows as a multiple of pre-pandemic levels (Source: BoE; ECB; CMMP)
The key message
The behaviour of UK and euro area households reached a potentially important inflexion point at the start of 4Q21. Household (HH) money flows moderated sharply in October 2021 while monthly flows of consumer credit hit new YTD highs.
Recall that HHs increased their money holdings significantly during the pandemic and built up (estimated) excess savings of £162bn in the UK and €285bn in the EA – a combination of forced and precautionary savings. This meant that the rise in broad money during the pandemic was a reflection of the deflationary forces of increased savings and delayed consumption.
The accumulation of money holdings peaked during 2Q20 and again in 4Q20 and the low point in terms of YoY declines in consumer credit demand was passed in February 2021. Monthly flows of consumer credit have been positive for the past six months and hit YTD highs in October 2021 in both regions. At the same time, the accumulation of money holdings has fallen back to 1.2x and 0.6x pre-pandemic levels in the UK and EA respectively.
Unfortunately, the recent rise in COVID-19 cases, the emergence of the omicron variant and renewed restrictions imposed by the UK and EA governments may result in these points being missed, or, worse still, the positive trends being reversed. That said, firmer economic foundations in both the UK and EA (and higher levels of vaccinations) suggest that both regions are in a stronger position to face renewed COVID challenges than they were a year ago.
Missing the point – the charts that matter
HH money flows
Monthly HH money flows in the UK (£bn) and multiple (x) of 2019 average flow (Source: BoE; CMMP)
HHs in the UK and EA increased their money holdings significantly during the COVID-19 pandemic. Monthly flows peaked at 6x pre-pandemic levels in the UK in May 2020 (see chart above) and 2.4x pre-pandemic levels in the EA a month earlier (see chart below). At the start of 4Q21, they had moderated to 1.2x and 0.6x pre-pandemic levels in the UK and EA respectively. A key building block for a sustained economic recovery.
Monthly HH deposit flows in the EA (EUR bn) and multiple (x) of 2019 average flow (Source: ECB; CMMP)
Excess HH savings
Estimated build up of excess HH savings in the UK (£bn) (Source: CMMP estimates)
In aggregate, and as a result, HHs have built up excess savings in the form of bank deposits of £162bn in the UK (see chart above) and €285bn in the EA (see chart below) since February 2020. These reflect a combination of forced savings (that may be released relatively quickly to support economic activity) and precautionary savings (that are unlikely to move straight into investment of consumption).
Estimated build up of excess HH savings in the EA (EUR bn) (Source: CMMP estimates)
As noted back in May (see “More bullish on UK consumption”) and confirmed by the ECB in August 2021 (see “Economic Bulletin, Issue 5”). The majority of these accumulated savings have accrued to HHs that already have sizeable savings, have higher incomes, and are older. Such HHs typically spend less from any extra savings they accumulate i.e. they have relatively low marginal propensities to consume. The release of these excess savings is likely to be only partial and gradual, therefore.
Impact on monetary aggregates
M1 as a percentage of M3 in the UK and EA (Source: BoE; ECB; CMMP)
HH behaviour had a marked impact on money supply dynamics during the pandemic with narrow money (M1) representing an ever-larger share of broad money (M3) in both the UK and EA (see chart above). As an example, overnight deposits contributed 6.8ppt to the total EA broad money growth of 7.6% in October 2021 alone (see chart below).
Contribution of M1 (ppt) to growth rate in EA M3 (% YoY) (Source: ECB; CMMP)
This matters because the expansion of broad money during the pandemic reflected the deflationary force of HHs increasing their savings and delaying consumption. Money sitting in overnight deposits contributes to neither growth nor inflation.
HH demand for consumer credit
Growth rates in consumer credit in the UK and EA (% YoY) (Source: BoE; ECB; CMMP)
Annual growth rates in consumer credit reached a low point in February 2021 in both the UK (-10% YoY) and the EA (-3% YoY). The rate of decline has narrowed subsequently to -1.0% in the UK in October. In the EA, annual growth rates turned positive two months later in April 2020 (see chart above).
Monthly consumer credit flows in the UK (£ bn) and EA (EUR bn) (Source: BoE; ECB; CMMP)
More importantly, monthly flows of consumer credit have been positive for the past six months and reached their highest levels YTD in both the UK (£0.7bn) and EA (€2.7bn) respectively (see chart above).
Conclusion
A moderation in monthly HH money flows and a recovery in demand for consumer credit represent important foundations for a sustained recovery in the UK and the EA. The rise in COVID-related risks comes at a very delicate and unfortunate time, therefore, for the recovery in both regions. It remains too early to say whether recent events will reverse these dynamics in a meaningful manner. The positive news is that firmer economic foundations in both the UK and EA suggest that both regions are in a stronger position to face these challenges than they were a year ago.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Growth in the wrong type of lending triggers ECB call for policy shift
The key chart
Growth rates (% YoY) in average RRE prices and loans for house purchase (Source: ECB; CMMP)
The key message
In its latest “Financial Stability Review” (November 2021), the ECB calls for a policy shift away from short term support measures towards “mitigating risks from higher medium term financial stability vulnerabilities, in particular emerging cyclical and real estate risks.”
This is a welcome development given the extent to which (unorthodox) policy measures have fuelled growth in the “wrong type of lending” to date, and the negative implications this has for future growth, leverage, financial stability and income inequality.
Macroprudential instruments include capital measures (e.g. higher risk weights) and borrower-based measures (e.g. LTV limits). Their adoption varies across the euro area currently, with six economies adopting a combination of both instruments, nine economies adopting borrower-based measures alone, and four economies having no measures in place (Germany, Spain, Italy and Greece).
Further tightening of existing instruments may be required in several economies where RRE vulnerabilities are continuing to build up, but Germany stands out given current house price and lending dynamics, the extent of RRE overvaluation and the absence of targeted macroprudential measures.
“Enough is enough”
Over the past two years, I have been highlighting the hidden risk that unorthodox monetary policies in the euro area (and elsewhere) were fuelling growth in the “wrong type of lending”. From this, I have argued that the resulting shift from productive COCO-based lending towards less-productive FIRE-based lending (see chart below) has negative implications for leverage, growth, financial stability and income inequality in the future.
Outstanding stock of private sector lending (EUR bn, LHS) broken down by type and share of FIRE-based lending in total lending (%, RHS) (Source: ECB; CMMP)
Earlier this month, I also argued that it was appropriate, therefore, to expect new macroprudential measures for residential real estate soon. The ECB agrees (finally). In their latest “Financial Stability Review” (November 2021), the ECB is calling for a policy shift away from short-term support towards mitigating risks from higher medium-term financial stability vulnerabilities including residential real estate (RRE) risks.
2Q21 RRE price growth (% YoY) plotted against level of pre-pandemic valuation (Source: ECB; CMMP)
The ECB’s analysis includes three key risk factors:
First, nominal house prices grew at 7.3% in 2Q21, the fastest rate of growth since 2005 (see key chart above)
Second, house price and lending dynamics have been much stronger in many countries with pre-existing vulnerabilities. For example, despite above average degrees of over-valuation pre-pandemic (ie, >4% estimated overvaluation), RRE prices grew at above-average rates (ie, >7% YoY) in Luxembourg, the Netherlands, Austria, Germany, and Belgium in the year to end 2Q21 (see chart above)
Third, there is evidence of a progressive deterioration in lending standards, as reflected in the increasing share of loans with high LTV ratios. The share of new loans with LTVs above 90% reached 52% in 2020 compared with only 32% in 2016 (see chart below)
The ECB also notes “high and rising levels of HH indebtedness”, but this is less of a risk, in my opinion, given that the HH debt ratio of 61% GDP is well below the BIS’ threshold of 85% GDP.
Share of loans with LTV >90% in total new loan production (Source: ECB; CMMP)
Macroprudential instruments include capital measures (eg higher risk weights) and borrower-based measures (eg, LTV limits). Their adoption varies across the euro area with six economies adopting a combination of both instruments (green bubbles in chart below), nine economies adopting only borrower-based measures (orange bubbles in chart below), and four economies having no measures in place – Germany, Spain, Italy and Greece (red bubbles in chart below, although Greece not shown).
RRE price growth plotted against mortgage loan growth 1H21 v 1H20. Size of bubbles represents HH debt ratio and colour represents current macroprudential framework (Source: ECB; CMMP)
Further tightening of existing instruments may be required in several economies where RRE vulnerabilities are continuing to build up, but Germany stands out given the combination of house price and lending dynamics, the extent of overvaluation and the lack of macroprudential measures.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Annual growth (% YoY) in EA private sector lending split between FIRE-based and COCO-based lending (Source: ECB; CMMP)
The key message
Is the ECB correct to argue that, “monetary policy measures continue to support lending conditions and volumes” in the euro area? Yes, but only up to a point.
On the supply-side, the APP, PEPP and TLTRO III programmes are having a positive impact on banks’ liquidity positions and overall market financing conditions. On the demand side, borrowing costs are at (mortgages) or close to (NFC loans) historic lows in nominal terms and at historically low and negative levels in real terms. So far, so good.
That said, lending volumes are unexciting in relation to recent trends and previous cycles and currently negative in real terms. No compelling volume story here.
More importantly, current policy measures are supporting the “wrong type of credit”.
Less-productive lending that supports capital gains through higher asset prices (FIRE-based lending) contributed 2.5ppt to the 3.2% total loan growth in September 2021. Worryingly, this is part of longer-term trend. While the outstanding stock of private sector loans hit a new high in September, the stock of productive lending that supports production and income formation (COCO-based lending) remains below its January 2009 peak.
This matters for two key reasons. First, the shift from COCO-based lending to FIRE-based lending has negative implications for leverage, growth, financial stability and income inequality (expect new macroprudential measures for residential real estate soon). Second, it re-enforces the importance of an on-going policy response that remains “fiscal, first and foremost”.
“How much? How productive?”
In its latest “Euro area bank lending survey”, the ECB argues that, “monetary policy measures continue to support lending conditions and volumes” in the euro area (EA). Is this correct?
The supply-side
“Liquidity-providing” monetary policy operations in EUR bn (Source: ECB; CMMP)
On the supply-side, EA banks report that “the ECB’s asset purchase programme (APP), the pandemic emergency purchase programme (PEPP), and the third series of targeted longer-term refinancing operations (TLTRO III) continues to have a positive impact on their liquidity positions and market financing conditions” (see chart above).
The demand-side
Composite cost-of borrowing for house purchases and NFC loans in nominal and real terms (Source: ECB; CMMP)
One the demand side, borrowing costs are at (mortgages) or close to (NFC loans) historic lows in nominal terms and at historically low and negative levels in real terms (see chart above). In September 2021, the composite cost-of-borrowing for house purchases hit a new low of 1.30% (-2.03% in real terms). The composite cost of borrowing for NFC’s was 1.48%, 0.8ppt above its March 2021 low, but a new low in real terms (-1.86%).
How exciting is the volume story?
Annual growth (% YoY) in private sector lending in nominal and real terms (Source: ECB; CMMP)
Lending volumes are unexciting in relation to recent trends and previous cycles and currently negative in real terms. Lending to the private sector grew 3.2% YoY in September 2021 both on a reported basis and after adjusting for loan sales and securitisation. In nominal terms, lending growth has been relatively stable since March 2021 but is 2ppt lower than the recent peak growth recorded in May 2020 (5.2% YoY). Lending growth in the current cycle is relatively subdued, however, in relation to past cycles (see chart above). Furthermore, in real terms, lending in September fell slightly when adjusted for HICP inflation.
No compelling volume story here.
Loan growth from the ECB perspective
Annual loan growth with ECB breakdown by borrower (Source: ECB; CMMP)
As an aside, the ECB typically classifies lending by type of borrower – households (HHs), non-financial corporations (NFCs), non-monetary financial corporations (NMFCs) and insurance companies and pension funds (ICPFs) – with further subdivisions based in the type of HH borrowing and the maturity of NFC borrowing.
In September 2021, HH lending contributed 2.2pt to the total 3.2% YoY growth, essentially mortgages. NFCs and NMFCs contributed 0.6ppt and 0.5ppt respectively but lending to ICPFs made a slight negative contribution of -0.1ppt.
Loan growth from the CMMP Perspective
CMMP analysis presents an alternative classification based on the productivity of credit use. Broadly speaking, lending can be spilt into two distinct types: lending to support productive enterprise; and lending to finance the sale and purchase of existing assets. The former includes lending to NFCs and HH consumer credit (and other HH lending) and is referred collectively here as “COCO-based” lending (COrporate and COnsumer). The latter includes loans to non-bank financial institutions (NBFIs) and HH mortgage or real estate debt and is referred collectively here as “FIRE-based” lending (FInancials and Real Estate).
Note that COCO-based lending typically supports production and income formation while FIRE-based lending typically supports capital gains through higher asset prices.
Supporting the “wrong type of credit”
Annual loan growth with CMMP breakdown by productivity of use (Source: ECB; CMMP)
Viewed from a CMMP perspective, current policy measures are supporting the “wrong type of credit”. Less-productive lending that supports capital gains through higher asset prices (FIRE-based lending) contributed 2.5ppt to the 3.2% total loan growth in September 2021 (see chart above).
Annual loan growth broken down by productivity of use since September 2006 (Source: ECB; CMMP)
Worryingly, this is part of a longer-term trend. As can be seen from the chart above, higher volumes in the pre-GFC period were more balanced with more-productive COCO-based lending accounting for 56% of total outstanding loans. Today, that share has fallen to 48%.
Outstanding stock (EUR bn) of COCO-based lending (Source: ECB; CMMP)
As noted in August 2021, while the outstanding stock of credit hit a new high in September, the stock of productive COCO-based lending (€5,470bn) remains below its January 2009 peak (€5,517bn). In other words, the aggregate growth in lending since early 2009 has come exclusively from FIRE-based lending which now accounts for 52% of the outstanding stock of loans (see chart below).
Outstanding stock (EUR bn) of COCO-based and FIRE-based lending (Source: ECB; CMMP)
Conclusion
The ECB is entitled to argue that monetary policy measures have supported lending conditions and volumes. However, current lending volumes are unexciting in relation to previous cycles and negative in real terms. Policy is also supporting the “wrong type” of credit – fuelling FIRE-based lending rather than productive COCO-based lending that supports production and income formation.
This matters for two key reasons. First, the shift from COCO-based lending to FIRE-based lending has negative implications for leverage, growth, financial stability and income inequality. During the COVID-19 pandemic, some national authorities eased macroprudential measures for residential real estate (RRE). This week, however, the ECB argued that further macroprudential measures should be considered where RRE vulnerabilities continue to build up. (Watch this space.) Second, it re-enforces the importance of an on-going policy response that remains “fiscal, first and foremost”.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Synchronised money cycles and messages from the UK and EA
The key chart
Broad money growth (% YoY) in UK and the euro area (Source: BoE, ECB; CMMP)
The key message
UK and euro area (EA) money cycles remain highly synchronised with the message from both region’s money sectors remaining one of “slowing momentum”.
At the start of 2021, I highlighted three key signals among these messages: are monthly HH deposit flows moderating; is consumer credit recovering; and are money and credit cycles re-synching with each other? The context here being that narrow money (M1) drove the expansion of broad money (M3) in both regions during the pandemic, reflecting the DEFLATIONARY forces of heightened uncertainty, increased (forced and precautionary) savings, reduced consumption and relatively subdued demand for credit.
While monthly flows of HH deposits are well below their respective peaks, they rose in both regions in August, notably in the UK where August’s flow was 2x pre-pandemic levels. Money sitting idly in overnight deposits contributes to neither growth nor inflation. Household uncertainly remains elevated and consumption muted (see also “Delaying the delayable”). Monthly consumer credit flows remain subdued in August and YoY growth rates were -2.4% in the UK and flat in the EA. Money and credit cycles remain out-of-synch with each other, presenting challenges to policy makers and investors alike and reminding us not to confuse current money cycles with previous versions. Furthermore, not only is private sector credit demand relatively subdued, it is also increasingly driven by FIRE-based lending (largely mortgages) rather than more productive COCO-based lending (largely NFC and consumer credit).
Economies and markets have benefitted from changing policy mixes that have been necessary and appropriate. Momentum in the key drivers of a sustained recovery is slowing, however, and further refuelling is required as we enter 4Q21.
Four charts that matter
Monthly HH deposit flows as a multiple of average 2019 monthly flows (Source: BoE; ECB; CMMP)
While monthly flows of HH deposits are well below their respective peaks, they rose in both regions in August, notably in the UK where August’s flow was 2x pre-pandemic levels (see chart above). Money sitting idly in overnight deposits contributes to neither growth nor inflation. Household uncertainly remains elevated and consumption muted.
Annual growth in UK and EA consumer credit (Source: BoE; ECB; CMMP)
Monthly consumer credit flows remain subdued in August and YoY growth rates were -2.4% in the UK and flat in the EA (see chart above).
Lending growth minus money supply growth in the UK and EA (Source: BoE; ECB; CMMP)
Money and credit cycles remain out-of-synch with each other (see chart above), presenting challenges to policy makers and investors alike and reminding us not to confuse current money cycles with previous versions.
Growth rates in private sector credit by type (Source: BoE; ECB; CMMP)
Furthermore, not only is private sector credit demand relatively subdued, it is also increasingly driven by FIRE-based lending (largely mortgages) rather than more productive COCO-based lending (largely NFC credit and consumer credit).
Conclusion
Economies and markets have benefitted from changing policy mixes that have been necessary and appropriate. Momentum in the key drivers of a sustained recovery is slowing, however, and further refuelling is required as we enter 4Q21.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
