Trends in cumulative HH and NFC financing flows (12-months, £bn) (Source: BoE; CMMP)
The key message
UK corporates and house buyers are reading the BoE’s script, even if consumers are not.
Cumulative 12-month financing flows to the household (HH) and corporate (NFC) sectors slowed to £8.3bn in November 2023, down from £65.2bn a year earlier (see key chart above).
Cumulative 12-month financing flows to the NFC sector have been consistently negative since January 2023
In November 2023, they were -£3.2bn compared with £3.2bn a year earlier i.e. corporates repaid debt throughout 2023
Note that the average cost of new NFC borrowing has risen by 495bp to 7.0% since the BoE began policy tightening (see chart below).
Trends in the average cost of new mortgages and NFC loans (%) (Source: BoE; CMMP)
Cumulative 12-month finance flows to the HH sector fell to £11.5bn in November, down from £61.3bn a year earlier
Lending for house purchases (mortgages) was net zero in November
The YoY growth rate for net mortgage lending was 0.3%, the lowest growth rate since the BoE’s monthly data series began back in March 1994
Note that the average cost of new mortgages has risen 384bp to 5.34% since the start of policy tightening (see chart above).
So what?
Financing flows to the UK private sector are falling sharply and reaching potential choke points for growth and much needed investment.
Beyond the headlines, there is a sharp contrast in terms of the dynamics of borrowing for consumption (resilient), investment (weak), and house purchases (slowing sharply).
While the message from the UK money sector remains relatively positive for on-going consumer demand, it is far more concerning with respect to investment and real estate.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Monthly consumer credit flows jumped to £2bn in November 2023
The key chart
Monthly flows (£bn) of UK consumer credit since November 2019 (Source: BoE; CMMP)
The key message
UK consumers are still not reading the BoE’s script – at least not fully.
Monthly flows of consumer credit rose to £2.0bn in November 2023 from £1.4bn in October 2023 and £1.5bn in September 2023 (see key chart above). The rise was largely attributable to a £0.5bn increase in borrowing on credit cards from £0.5bn in October 2023 to £1.0bn in November 2023.
The annual growth rate in the stock of consumer credit rose to 8.6% YoY, the highest rate since September 2018.
So what?
The BoE argues that, “higher interest rates make it more expensive for people to borrow money and encourages them to save.” The cost of borrowing has increased and households are saving more too. However, they also continue to borrow to fund consumption – in November the amount was 1.7x the average pre-pandemic flow.
In short, the BoE’s policy appears to resemble a three-legged stool that is missing an important leg…
Please note that the summary comments and chart above are abstracts of more detailed analysis that is available separately.
What have the “messages from the money sector” taught us in 2023?
The key chart
Visual summary of the CMMP Analysis framework linking all economic sectors together (Source: CMMP)
The key message
The key message from CMMP Analysis is that the true value in analysing developments in global finance lies less in considering investments in banks’ equity and more in understanding the implications of the relationship between the money sector and the wider economy for macro policy, corporate strategy, investment decisions and asset allocation.
The 2023 “messages from the money sector” included the importance of post-GFC debt dynamics, the risks of policy errors, the failure of banks to support productive economic activities, and the increasing abuse of macro statistics.
The seven key lessons were:
The risk of a Chinese balance sheet recession dominated 2023 and will DOMINATE 2024 too
“US bears” ignored structural shifts in US debt dynamics post-GFC and underestimated the RESILIENCE OF THE CONSUMER as a result
Aggregate demand in credit-driven economies is equal to income (GDP) PLUS THE CHANGE IN DEBT. Policy makers continue to ignore this truism at OUR peril
The ECB’s policy celebrations may prove PREMATURE
UK policy making is still based on UNBELIEVABLE forecasts and FLAWED macro thinking
Banks are failing to support PRODUCTIVE ACTIVITY and the SME sector in particular
The ABUSE of macro statistics is rife – beware of “panic charts” and their accompanying narratives
Seven lessons from the money sector in 2023
The importance of post-GFC debt dynamics
Lesson #1: the risk of a Chinese balance sheet recession dominated 2023 and will dominate 2024 too
January 2023: Trends in Japanese, Spanish and Chinese private sector debt ratios (% GDP) (Source: BIS; CMMP)
CMMP Analysis began 2023 by questioning the popular, “China-opening story“. We highlighted three structural risks to this narrative – (1) the level of private sector debt, (2) the rate of growth of household debt, and (3) the affordability of private sector debt. We asked two questions.
First, what happens if rather than seeking to maximise profit/utility as traditional economics assumes, the Chinese private sector turns to minimising debt or maximising savings instead?
Second, and following on from this, what if China experiences a balance sheet recession instead?
December 2023: Trends in “excess credit growth” in China since June 2013 (Source: BIS; CMMP)
The balance sheet narrative remained on hold during 2023, but risks remain as we enter 2024. All sectors of the Chinese economy are increasing leverage still. The Chinese government is the main driver here, rather than the private sector, however. Crucially, the dynamics of Chinese money creation and potential growth are shifting. Credit agencies may (mistakenly) wish for lower levels of government debt in China, but given current debt dynamics it will be fiscal policy/government spending that will have to do the heavy lifting in 2024 if China’s growth is to recover.
Lesson #2: “US bears” ignored structural shifts in US debt dynamics post-GFC and underestimated the resilience of the consumer as a result
January 2023: Trends in the stock of US consumer credit ($tr) and the consumer credit to DPI ratio (%) (Source: FRED; CMMP)
CMMP Analysis also began 2023 by questioning the equally popular, “US consumer slowdown narrative”. We argued that “US bears” were ignoring the key structural shifts in US debt dynamics that saw the US leading the advanced world in the structural shift away from high-risk HH debt towards relatively low risk public debt in the post-GFC period. In September 2023, we noted greater affordability risks in other developed economies such as Canada, Switzerland, Sweden, France and Finland and in emerging markets such as Brazil, China and Korea instead.
December 2023: Trends in monthly flows of US consumer credit (Source: FRED; CMMP)
That said, we also noted signs that the US consumer was starting to crack as the year progressed. Quarterly consumer credit flows in the 3Q23 ($4bn) were the weakest since 2Q20, and only a very small fraction of the pre-pandemic average quarterly flow of $45bn. Monthly flow data for October 2023, also suggested that momentum weakened further at the start of 4Q23.
Note the key differences between China and the US here – China’s challenges are more structural in nature, while the US’s challenges are more cyclical.
The risks of policy errors
Lesson #3: Aggregate demand in credit-driven economies is equal to income (GDP) PLUS THE CHANGE IN DEBT. Policy makers continue to ignore this truism at OUR peril.
In September 2023, CMMP Analysis argued that central bank decision making that appears largely “data independent” in relation to private sector credit dynamics is unlikely to produce positive economic outcomes. Instead, it increases the likelihood of policy errors, especially in credit-driven economies.
September 2023: Trends in the UK PS debt ratio (RHS) and PSC relative growth factor (LHS) (Source: BIS; CMMP)
The fundamental error is to ignore that aggregate demand in a credit-driven economy is equal to income (GDP) PLUS THE CHANGE IN DEBT. The addition of the change in debt means that, in reality, aggregate demand is far more volatile than it would be if income alone was its source (as typically assumed). This is especially true for highly indebted economies.
If Schumpeter could understand this in 1934, why can’t policy makers understand it in 2024?
Lesson #4: The ECB’s celebrations may prove to be premature
December 2023: Trends in PS financing flows (EUR bn, 12m cum flows) and nominal NFC and HH borrowing costs (%, RHS) (Source: ECB; CMMP)
The risks that these celebrations may prove to be premature are obvious, however, or at least they should be. While monetary policy transmission in the euro area is working as textbooks suggest, both the pace and scale of current tightening is unprecedented. The ECB lacks a playbook for such a scenario and EA economies now find themselves in uncharted territory. Policy tightening continued even as the EA money sector was indicating increases stresses for banks, households and corporates. The end result – a combination of NEGATIVE financing flows to the private sector, historically high policy rates and elevated costs of borrowing – is unlikely to be sustainable in 2024.
Lesson #5: UK policy making is based on unbelievable forecasts and flawed macro thinking
November 2023: Historic and forecast trends in sectoral balances for the UK private and public sectors and the RoW expressed as % GDP (Source: OBR; CMMP)
Official OBR forecasts for the UK economy remain unbelievable when viewed through CMMP Analysis’ preferred sector balances perspective. The March 2023 version suggested a return to the pre-pandemic world of economic imbalances and an economy forecast to remain heavily dependent on net borrowing from abroad – the irony of post-Brexit Britain. The November 2023 version presented a more balanced outlook and a more realistic forecast for private sector dynamics but was simply too dull to be true.
December 2023: Trends in UK PS debt ratio (% GDP, RHS) and relative growth versus nominal GDP (3Y CAGR %, LHS) (Source: BIS; CMMP)
The UK private sector debt ratio fell back to its March 2022 level at the end of 2Q23. This matters because neither Jeremy Hunt (the current UK Chancellor) nor Rachel Reeves (his likely successor) appear to recognise the folly of combining austerity with private sector deleveraging (“pre-COVID Britain”). The next general election will be fought on the wrong macro battleground as a result. Both parties will repeat the flawed narrative that governments (that enjoy monetary sovereignty) face the same financial constraints as households and that public debt is a problem while largely ignoring private debt. A depressing thought for the year ahead.
The failure of banks
Lesson #6: Banks are failing to support productive activity and the SME sector in particular
February 2023: Trends and breakdown of UK FIRE-based (red and pink) and COCO-bases (blue) lending (£bn) (Source: BoE; CMMP)
A more appropriate macro policy debate in the run-up to the next election would focus on the role of banks. UK banking, for example, is heavily geared towards less-productive FIRE-based lending that supports capital gains rather than productive COCO-based lending that supports investment, production and income formation.
October 2023: Trend in the outstanding stock of SME loans since 2013 (£bn) (Source: BoE; CMMP)
UK banking also fails SMEs, the lifeblood of the UK economy. Only 22 pence in every pound lent in the UK is for productive purposes and only c.7pence is lent to SMEs. This is despite the fact that SMEs account for 50% of private sector turnover and 60% of employment. SMEs cannot invest fully in growth, job creation, innovation and equality if and when: (1) their access to external capital is constrained by LT structural factors; (2) flows of financing (both loans and overdrafts) are negative; and (3) their cost of borrowing is rising so rapidly.
The abuse of macro statistics
Lesson #7: The abuse of macro statistics is rife – beware of “panic charts” and their accompanying narratives.
CMMP Analysis suggests that US public sector debt and trends in narrow money (M1) are the most widely abused macro statistics of the year.
May 2023: 50 years of US public sector debt dynamics – plotted differently! (Source: FRED; CMMP)
The abuse of US public sector debt data involves five elements. First, ignoring the fact that public debt is both a liability for the government sector and an asset of the non-government sector. Second, making no comparison with GDP. Third, ignoring inflation. Fourth, presenting long time series data using linear scales. Fifth and finally, ignoring private sector debt dynamics completely (see also lesson #2 above).
November 2023: Growth trends (% YoY) in narrow money (M1) and other short term deposits (M2-M1) (Source: ECB; CMMP)
The abuse of monetary aggregate statistics is more understandable given that growth in narrow money is falling rapidly, and that real growth rates in M1 typically display leading indicator properties with real GDP. This means that M1 dynamics make great headlines for sure, but they only tell one part of the macro and banking stories. The rising opportunity cost of holding money, on-going portfolio rebalancing and the mechanics of money creation are important too. Policy normalisation leads to natural re-adjustments in the structure of MFI consolidated balance sheets. This can and does create dramatic movements in individual items and monetary variables such as M1 and increases the risk of misinterpretation.
In short, monetary aggregates still matter. To return to the key message from CMMP Analysis, they tell us a great deal about the interaction of the banking sector and the wider economy, but they need interpreting with due care and attention…
Thank you for reading and very best wishes for a very happy and healthy new year.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
The UK private sector debt ratio is back to March 2002 levels
The key chart
Trends in UK private sector debt ratio (% GDP, RHS) and relative growth versus nominal GDP (3Y CAGR %, LHS) (Source: BIS; CMMP)
The key message
Don’t whisper it softly this time – shout it out loudly instead:
…the UK private sector debt ratio is back to March 2002 levels
This matters because neither Jeremy Hunt (the current UK Chancellor) nor Rachel Reeves (his likely successor) appear to recognise the folly of combining austerity with private sector deleveraging (“pre-COVID Britain”). The next election will be fought on the wrong macro battleground as a result.
According to the latest BIS data release, the UK private sector’s debt ratio was 147% GDP at the end of 2Q23, down from its all-time high of 186% GDP in 1Q10 and its recent high of 177% GDP in 1Q21 (see key chart above).
The corporate sector debt ratio has fallen from 90% GDP in 4Q08 to 66% GDP in 2Q23, while the household sector debt ratio has fallen from 98% GDP in 4Q09 to 81% in 2Q23. The UK now joins the US, Germany and Italy among the small group of advanced nations where both sector’s debt ratios are below the BIS threshold limits, above which debt is considered a drag on future growth.
Note that the private sector’s share of total UK debt has fallen from almost 80% at the time of the GFC to 62% now. In short, the UK has followed the US in substituting higher-risk household debt with lower risk government debt since the GFC.
As the UK approaches a general election next year, the macro policy debate should be around:
UK banking is geared currently towards less-productive FIRE-based lending that supports capital gains rather than productive COCO-based lending that supports investment, production and income formation. UK banking also fails SMEs – the lifeblood of the UK economy. Only 22 pence in every pound lent in the UK is for productive purposes and only 7 pence is lent to SMEs. This is despite the fact that SMEs account for 50% of private sector turnover and 60% of employment.
Equally troubling, the UK policy debate focuses on reducing the level of government borrowing further based on the flawed narrative that governments face the same financial constraints as households and equally flawed macro thinking that sees public debt as a problem while largely ignoring private debt. The irony for “post-Brexit” Britain is that this leaves us increasingly dependent on financial flows from the RoW. A depressing thought at the end of the year.
Time for shouting not whispering…
Please note that summary comments and chart above are abstracts from more detailed analysis that is available separately.
The OBR’s latest UK forecasts seen from a sectoral balances perspective
The key chart
Historic and forecast trends in sectoral balances for the UK private and public sectors and the RoW expressed as % GDP (Source: OBR; CMMP)
The key message
Viewed from a sectoral balances perspective, the Office of Budget Responsibility’s (OBR’s) latest “Economic and Fiscal Outlook” for the UK appears “too dull to be true”.
Too dull to be true?
Sectoral balances illustrate the financial relationship between different economic sectors. Between the UK private sector (households and corporates), the UK public sector and the rest-of-the-world (RoW), for example, in the key chart above.
The approach builds on the key accounting identity pioneered by the late Wynne Godley that states that:
Domestic private balance + domestic public balance + foreign balance (must) = zero
Pre-COVID, the UK was characterised by unsustainable macro imbalances. Both domestic sectors were running net borrowing (or deficit) positions at the same time. This left the UK increasingly reliant on net lending from the rest-of-the world – the ultimate irony for “post-Brexit Britain”.
The pandemic changed everything. The private sector shifted to unprecedented levels of net lending/surpluses. At its peak in 2Q20, private sector surpluses/disinvestment totalled almost 25% GDP. Fortunately, the UK government’s response was timely, rapid and appropriate with an offsetting deficit/investment of 25% GDP (see key chart above).
Recent (post-pandemic) OBR outlooks forecast a return to the pre-COVID world of unsustainable macro imbalances. The latest version is more optimistic, thanks in part to improved household dynamics.
In short, the OBR forecasts a balanced UK private sector – a net lending position for the household sector of 1.3% GDP in 1Q29 down from 2.6% GDP in 2Q23, but close to average levels, and a return to investment or net borrowing by UK corporates equivalent to -0.9% GDP. The OBR also expects net borrowing by the government to fall from -7.3% GDP to only -0.7% GDP over the same period.
The OBR concludes that, “Following large swings during the pandemic and energy crisis, sectoral balances are expected to return to historically more normal levels over the forecast period.”
A more cynical observer may conclude that the forecasts are simply too dull and/or too smooth to be true…
Please note that the summary comments and chart above are abstracts from more detailed analysis that is available separately.
UK and EA consumers are still borrowing, despite higher rates
The key chart
Quarterly flows in UK and EA consumer credit (multiple of pre-pandemic flows) (Source: BoE; ECB; CMMP)
The key message
The Bank of England and ECB both argue that, (1) the best way they can make sure inflation comes down and stays down is to raise rates, and (2) that higher rates make it more expensive to borrow and hence people will spend less on goods on services.
Great in theory, but consumer credit flows have remained surprisingly strong during 3Q23 and in September 2023 when monthly flows in both regions were 1.2x their average pre-pandemic levels.
While unprecedented increases in the cost of borrowing have resulted in a very sharp slowdown in overall financing flows to the UK and EA private sectors, consumers in both regions are “still bashing the plastic”.
Bad news for investment and real estate, perhaps, but better news for consumer goods and services (at least for now).
And yet
“Higher interest rates make it more expensive for people to borrow money and encourages them to save. That means that, overall, they will tend to spend less. If people on the whole spend less on goods and services, prices will tend to rise more slowly. That lowers the rate of inflation”
Bank of England, 2 November 2023
UK consumer credit flows
UK consumer credit flows totalled £4.4bn in 3Q23, up from £4.3bn in the 2Q33, but down from £4.5bn in 1Q23 (see key chart above). Consumer credit flows in the past three quarters have been 1.2x their average pre-pandemic level of £3.6bn.
Trends in UK monthly consumer credit flows (Source: BoE; CMMP)
Monthly consumer credit flows during the 3Q23 were £1.3bn in July, £1.7bn in August, and £1.4bn in September. These resilient flows were 1.1x, 1.4x and 1.2x the average monthly pre-pandemic flow of £1.2bn (see chart above).
EA consumer credit flows
EA consumer credit flows totalled €9.3bn in 3Q23, up from €3.4bn in 2Q23 and €4.2bn in 1Q23. Consumer credit demand, which had been supressed since the pandemic, almost recovered to its pre-pandemic average level of €10.3bn.
Trends in EA monthly consumer credit flows (Source: ECB; CMMP)
Monthly consumer credit flows during the 3Q23 were €2.5bnbn in July, £3.0bn in August, and £3.9bn in September. These flows were 0.7x, 0.9x and 1.2x the average monthly pre-pandemic flow of €3.4bn (see chart above).
Conclusion
While unprecedented increases in the cost of borrowing have resulted in a very sharp slowdown in overall financing flows to the UK and EA private sectors, consumers in both regions are “still bashing the plastic”.
Bad news for investment and real estate, perhaps, but better news for on-going demand for goods and services.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
(Some) things may not be getting worse, but significant financing challenges remain
The key chart
Trends in net lending flows to UK SMEs (Source: BoE; CMMP)
The key message
There was little for UK SMEs to cheer in the latest “Money and Credit” data release from the Bank of England. The only positives for this systemically important economic sector were: (1) monthly negative financing flow dynamics did not get worse; and (2) the average cost of borrowing fell slightly.
SMEs have been repaying bank loans and overdrafts since October 2022. In September 2023, net repayments totalled -£284m, less than -£747m in August and -£1,184m in July
Cumulative flows in the twelve months to September 2023 increased to -£9.9bn from -£9.2bn and -£8.8bn in August and July respectively, however
Note that lending to real estate activities (that involve buying, selling and renting of own or leased real estate) is the only sub-sector to experience positive 12-month cumulative lending flows (£0.3bn in September 2023). With monthly repayments in four of the past six months, these cumulative flows are slowing sharply now, reflecting wider challenges for the sector
The average cost of borrowing for SMEs fell slightly from 7.65% in August to 7.59% in September 2023. Nonetheless, the 514bp increase in the cost of borrowing since the Bank of England began tightening is still larger than for all corporates (460bp to 6.63%), secured HH borrowing (343bp to 5.01%) an unsecured HH borrowing (246bp to 8.73%).
In short, and to repeat recent messages, UK SMEs continue to face significant systemic and cyclical financing challenges that limit their ability to invest fully in growth, job creation and innovation. Are the UK government and the Bank of England watching carefully enough…?
Little to cheer for UK SMEs
Trends in net lending flows to UK SMEs (Source: BoE; CMMP)
SMEs have been repaying bank loans and overdrafts since October 2022. In September 2023, net repayments totalled -£284m, compared with -£747m in August 2023 and -£1,184m in July 2023 (see columns in chart above).
Cumulative flows in the twelve months to September 2023 increased to -£9.9bn from -£9.2bn and -£8.8bn in August 2023 and July 2023 respectively (see dotted line in chart above).
Trends in net lending flows to key RE sub-sector (Source: BoE; CMMP)
Dynamics in the two sectors that have the largest market shares of total loans – real estate (41% share) and trade (9% share) – matched the overall sector dynamics (unsurprisingly given their size).
Note however that real estate comprises two subsectors: the first and largest involves buying, selling and renting of own or leased real estate; the second (much smaller) involves real estate activities on a fee or contractual basis.
The former is the only sub-sector within SME lending to experience positive 12-month cumulative lending flows (£0.3bn in September 2023). With monthly repayments in four of the past six months, these cumulative flows are slowing sharply now reflecting wider challenges for the UK real estate sector (see chart above).
Trend in the average cost of borrowing for UK SMEs (Source: BoE; CMMP)
The average cost of borrowing for SMEs fell slightly from 7.65% in August 2023 to 7.59% in September 2023 (see chart above). Nonetheless, the 508bp increase in the cost of borrowing since the Bank of England began tightening is still larger than the average costs of borrowing for all corporates (460bp to 6.63%), secured HH borrowing (343bp to 5.01%) an unsecured HH borrowing (246bp to 8.73%).
Changes in the cost of borrowing since BoE tightening began by sector (Source: BoE; CMMP)
Conclusion
To repeat last month’s message – SME’s access to finance is systemically important to the UK economy. Broad-based weakness in lending across all SME sectors or industry groups is concerning, therefore. It supports the hypothesis that SMEs are putting both investment and business development on hold.
In short, current financing conditions are limiting SMEs’ ability to invest fully in growth, job creation and innovation. Are the UK government and the Bank of England watching carefully enough…?
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Financing flows to the UK private sector slowing very sharply
The key chart
Trends in cumulative financing flows to the UK private sector (12-months, £bn) (Source: BoE; CMMP)
The key message
The latest “Money and Credit – September 2023” data release from the Bank of England (BoE) confirms the sharp slowdown in financing flows to the UK private sector. This story is not unique to the euro area.
Cumulative monthly financing flows fell from £98bn in the 12 months to September 2022 to net repayments of £64bn in the twelve months to August 2023 (see key chart above). This data includes volatile flows to non-intermediating financial companies (the green columns). Excluding these, financing flows to corporates (PNFCs) and HHs fell from £64bn to £11bn over the period.
The average cost of borrowing for PNFCs has increased 460bp from 2.03% in December 2021 (when BoE rate increases began) to 6.63% in September 2023. In response, PNFCs have repaid loans in six of the past twelve months and cumulative 12-month financing flows have been negative for the past nine months. Behind the headlines, UK SMEs also face the extra “dual challenge” of lower lending volumes (negative YoY growth since August 2021) and even higher borrowing costs (7.59% average, up 508bp since December 2012).
The average costs of secured and other HH lending have increased by 343bp (from 1.58% to 5.01%) and 246bp (from 6.27% to 8.73%) respectively over the same time-period. HHs have repaid loans in three of the past six months and cumulative 12-month financing flows have declined from £60bn in the 12 months to September 2022 to £17bn in the twelve months to August 2023.
So what?
As noted in previous posts, the BoE and the ECB both lack playbooks for such aggressive periods of monetary tightening. Financing flows to the UK and EA private sectors are falling sharply and reaching a potential “choke point” for growth and much-needed investment.
Central bankers may argue that this suggests that the transmission of monetary policy is working. Others might view such as rapid pace of adjustment as an indicator that the risks of policy errors and risks to future growth are rising very sharply…
Tightening the UK choke hold further
The latest “Money and Credit – September 2023” data release from the Bank of England (BoE) confirms the sharp slowdown in financing flows to the UK private sector. This story is not unique to the euro area.
The collapse in cumulative 12-month financial flows to the UK private sector (12 months to September, £bn) (Source: BoE; CMMP)
Cumulative monthly financing flows fell from £98bn in the 12 months to September 2022 to net repayments of £64bn in the twelve months to August 2023 (see chart above). This data includes volatile flows to non-intermediating financial companies. Excluding these, financing flows to corporates (PNFCs) and HHs fell from £64bn to £11bn over the period.
Trends in the average cost of new loans to UK PNFCs (%) since September 2018 (Source: BoE; CMMP)
In response to the 460bp increase in the average cost of borrowing from 2.03% in December 2021 (when the BoE rate increases began, see chart above) to 6.63% in August 2023, PNFCs have repaid loans in six of the past twelve months.
Despite three consecutive months of positive flows to PNFCs between July and September 2023, cumulative 12-month financing flows have been negative for the past nine months. In the 12 months to September 2023, PNFCs repaid £5.6bn in loans (see chart below).
Trends in financing flows (£bn) to UK PNFCs (monthly LHS, cum 12 months RHS) (Source: BoE; CMMP)
Note also that, behind the headlines, the average interest rate on new loans to SMEs has increased by 508bp from 2.51% in December 2021 to 7.59% in September 2023.
Trends in growth rates (% YoY) in corporate loans since September 2018 (Source: BoE; CMMP)
The annual YoY growth rate in lending to SMEs has been negative since August 2021 (see chart above). In short, SMEs face the dual challenge of lower lending volumes and higher borrowing costs (see the “How can UK SMEs invest in growth and job creation…” series).
Trends in the average cost of new loans to UK HHs (%) since September 2018 (Source: BoE; CMMP)
In response to a 343bp increase in the average cost of new secured HH lending (the largest segment of HH borrowing) and 246bp in the average cost of other HH lending (see chart above), HHs have repaid loans in three of the past six months. Cumulative financing flows have fallen from £60bn in September 2022 to £17bn in September 2023 (see chart below).
Trends in financing flows (£bn) to UK HHs (monthly LHS, cum 12 months RHS) (Source: BoE; CMMP)
Conclusion
The BoE and the ECB lack playbooks for such aggressive periods of monetary tightening. Financing flows to the UK and EA private sectors are falling sharply and reaching a potential “choke point” for growth and much-needed investment.
Central bankers may argue that this suggests that the transmission of monetary policy is working. Others might view such as rapid pace of adjustment as an indicator that the risks of policy errors and risks to future growth are rising very sharply…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Contribution to total growth (ppt) plotted against share of total loans (%) (Source: BoE; CMMP)
The key message
Weakness in financing flows to UK SMEs (see, “How can UK SMEs invest in growth and job creation (II)?”) reflects broad-based, negative growth across all sectors or industry groups. While focusing (correctly) on addressing the challenge of inflation, policy-makers should remember that investment and business development matter too.
Every SME sector or industry group saw YoY declines in their outstanding stock of loans in August 2023. The largest decline was in recreation loans (-16% YoY), the smallest in real estate loans (-3% YoY). The total outstanding stock of SME loans fell by 8% YoY.
The trade, construction and real estate sectors were the largest contributors to this negative growth. They contributed -1.5ppt, -1.4ppt and -1.1ppt to the total -8% YoY decline respectively. These dynamics illustrate clearly the bias towards real estate – the smallest absolute decline but the third largest contribution to the total slowdown – and, to a lesser extent towards trade and construction.
Lending to these three sectors dominates SME lending in the UK. Collectively they account for just under half of the total SME loans, with the real estate sector accounting for 41% of total SME loans alone.
Real estate: monthly flows have been negative every month since February 2023. More importantly, the cumulative 12m flows that had turned positive in the 12m to January 2023, have been negative since then. Further confirmation of the changing fortunes in the wider real estate sector.
Wholesale and retail trade: monthly flows have been negative since October 2022. Cumulative 12m flows have been declining consistently since then to reach -£1.8bn in the 12 months to July and August 2023.
Construction: monthly flows have been persistently negative. Cumulative net flows remain negative at -£1.8bn in the 12 months to August 2023 but “less negative” than the -£2.1bn flows in November 2022, December 2022 and January 2023.
SMEs’ access to finance is systemically important to the UK economy. The broad-based weakness in lending across all sectors or industry groups is concerning and supports the wider hypothesis that SMEs are currently putting both investment and business development on hold. The influence of real estate also indicates that the bias towards less productive FIRE-based lending in the UK extends into the vital SME sector too.
“Looking behind the negative financing flows to UK SMEs?”
Trends in net lending flows to UK SMEs (Source: BoE; CMMP)
The persistent weakness in lending to the UK SME sector described in “How can UK SMEs invest fully in growth and job creation (II)?”, and illustrated in the chart above, reflects broad-based, negative growth across all sub-sectors or industry groups.
Annual growth rates in lending (% YoY) broken down by sector (Source: BoE; CMMP)
Every SME sector or industry group saw YoY declines in their outstanding stock of loans in August 2023 (see chart above). The largest decline was seen in the case of recreation loans (-16% YoY), the smallest in real estate loans (-3% YoY). The total outstanding stock of SME loans fell by 8% YoY.
The only exception here (and an important one!) is a sub-sector within real estate lending. The stock of lending for “buying, selling and renting of own or leased real estate”, which accounts for 31% of total SME lending, rose 1% YoY in August 2023.
Contribution to total growth (ppt) plotted against share of total loans (%) (Source: BoE; CMMP)
The trade, construction and real estate sectors were the largest contributors to this negative growth. They contributed -1.5ppt, -1.4ppt and -1.1ppt to the total -8% YoY decline respectively (see chart above). These dynamics illustrate clearly the bias towards the real estate sector in particular – the smallest absolute decline but the third largest contribution to the total slowdown.
Individual sector share (LHS) and cumulative share (RHS) by sector (Source: BoE; CMMP)
Lending to the real estate, trade and construction sectors dominates SME lending in the UK. Collectively these three sectors account for just under half of the total SME loans, with the real estate sector accounting for 41% of total loans alone. Once again, the UK’s skew towards less-productive FIRE-based lending is evident in the case of SME lending.
Trends in net lending flows to real estate (Source: BoE; CMMP)
Monthly flows to the real estate sector have been negative every month since February 2023 (see chart above). More importantly, the cumulative 12m flows that had turned positive in the 12m to January 2023, have been negative since then. Further confirmation of the changing fortunes in the wider real estate sector.
The negative growth contributions of the trade and construction sectors reflect both the size and lending dynamics of both sector. Both sectors account for 9% of total loans and both saw their outstanding stock decline by 15% YoY in August 2023. Only the much smaller recreational sector saw a larger YoY decline.
Trends in net lending flows to wholesale and retail trade (Source: BoE; CMMP)
Monthly flows to the wholesale and retail trade sectors have been negative since October 2022 (see chart above). Cumulative 12m flows have been declining consistently since then to reach -£1.8bn in the 12 months to July and August 2023.
Trends in net lending flows to construction (Source: BoE; CMMP)
Monthly flows to the construction sector have been negative every month over the period shown. Cumulative net flows remain negative at -£1.8bn in the 12 months to August 2023 but “less negative” than the -£2.1bn flows in November 2022, December 2022 and January 2023.
Conclusion
SMEs’ access to finance is systemically important to the UK economy. The broad-based weakness in lending across all sectors or industry groups is concerning and supports the hypothesis that SMEs are currently putting both investment and business development on hold. The influence of real estate also indicates that the bias towards less productive FIRE-based lending in the UK extends into the vital SME sector too.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
…when their cost of borrowing is rising so rapidly?
The key chart
Impact of policy tightening on the cost of borrowing for different UK sectors (Source: BoE; CMMP)
The key message
How can UK SMEs invest in growth and job creation when their cost of borrowing is rising so rapidly?
The average cost of new loans for SMEs has increased by 514bp from 2.51% when policy rate rises began in December 2021 to 7.65% in August 2023. This increase is greater than the respective increases in the average cost of borrowing for all NFCs (494bp to 6.97%), secured HH borrowing (324bp to 4.82%) and other HH borrowing (280bp to 9.07%). The spread between the average cost of borrowing for SMEs and the average cost for all NFCs has also widened slightly over the period (although only back in-line with pre-pandemic levels).
In response, some SMEs have been able to pass on the increased cost of borrowing to their customers. They are also more active in switching between funding providers and in considering alternative forms of finance.
Nonetheless, the rapid transmission of the Bank of England’s monetary policy to their cost of borrowing is another reason why SMEs are delaying plans for investment and other business development opportunities.
Returning to the central message of this series of three posts.
SMEs access to external finance is systemically important to the UK economy. They account for c.50% of private sector turnover and c.60% of employment. SMEs cannot invest fully in growth, job creation, innovation and equality, however, if and when:
their access to external capital is so constrained by LT structural factors;
flows of financing (both loans and overdrafts) are negative; and
their cost of borrowing is rising so rapidly
Government-backed institutions such as the British Business Bank and the Scottish National Investment Bank are actively working to make financial markets work better for SMEs and thereby drive sustainable growth and prosperity across the UK. Challenger banks and specialist lenders (e.g. Bibby Financial Services) are making a positive impact too in terms of both the volume of funding and the range of financing alternatives.
In short, the UK government, government-backed institutions and the private sector are combining successfully. That said, the challenges of repositioning the UK finance industry away from largely supporting capital gains (FIRE-based lending) to supporting production and income formation (COCO-based lending) instead, remain considerable. In the meantime, the wider UK economy remains the real loser here…
How can UK SMEs invest in growth and job creation (III)
This is the last of three short posts examining the challenges faced by UK SMEs in investing fully in growth and job creation. The previous posts focused on the structural and cyclical challenges relating to the volume of external financing. This post considers the cost of external financing, and the cost of bank lending specifically.
Trend in the average cost of borrowing for UK SMEs (Source: BoE; CMMP)
The average cost of new loans for SMEs has increased by 514bp from 2.51% when policy rate rises began in December 2021 to 7.65% in August 2023 (see chart above). This increase is greater than the respective increases in the average cost of borrowing for all NFCs (494bp to 6.97%), secured HH borrowing (324bp to 4.82%) and other HH borrowing (280bp to 9.07%), as shown in the graph below.
Changes in the cost of borrowing since BoE tightening began by sector (Source: BoE; CMMP)
The spread between the average cost of borrowing for SMEs and the average cost for all NFCs has also widened slightly from 48bp to 68bp over the period, but is below the recent peak of 119bp in November 2022. The current spread is also in-line with the average spread in the pre-pandemic period (see chart below).
Comparison of trends in cost of borrowing for SMEs and all NFCs (Source: BoE; CMMP)
How are SMEs responding?
According to a recent survey by Close Brothers Asset Finance, 60% of SMEs have been able to pass on the rising cost of financing to their customers. At the same time, 36% of those surveyed have switched funders in order to access more attractive deals and 52% have considered alternative forms of funding e.g. asset finance.
UK Finance research suggests that SMEs are utilising existing facilities while also drawing down on deposit holdings. That said, their survey also concludes that, “plans for investment or other business development opportunities appear to be on the back burner.” (UK Finance, October 2023).
Conclusion – the central message of this series
SMEs access to external finance is systemically important to the UK economy. They account for c.50% of private sector turnover and c.60% of employment. SMEs cannot invest fully in growth, job creation, innovation and equality, however, if and when:
their access to external capital is so constrained by LT structural factors;
flows of financing (both loans and overdrafts) are negative; and
their cost of borrowing is rising so rapidly
Government-backed institutions such as the British Business Bank and the Scottish National Investment Bank are actively working to make financial markets work better for SMEs and thereby drive sustainable growth and prosperity across the UK. Challenger banks and specialist lenders (e.g. Bibby Financial Services) are making a positive impact too in terms of both the volume of funding and the range of financing alternatives.
In short, the UK government, government-backed institutions and the private sector are combining successfully. That said, the challenges of repositioning the UK finance industry away from largely supporting capital gains (FIRE-based lending) to supporting production and income formation (COCO-based lending) instead, remain considerable. In the meantime, the wider UK economy remains the real loser here…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
