…in forecasts that assume unsustainable end-games?
The key chart
Historic and forecast trends in financial sector balances for the UK private sector, government and the RoW expressed as % GDP (Source: OBR; CMMP)
The key message
Seen from the perspective of financial sector balances, the latest OBR forecasts for the UK economy and public finances tell us three things.
First, the UK government’s response to the COVID-19 pandemic was timely, necessary and appropriate.
Second, the financial relationship between UK households, corporates, government and the rest-of-the-world will remain broadly unchanged during 2021.
Third, (obvious and familiar) risks to the medium-term forecast remain to the downside and imply persistent and significant fiscal and current account deficits (little has changed since November 2020).
Somewhat surprisingly, given the significant event risk that the Covid-19 pandemic represents, the medium-term outcomes forecast in March 2020, November 2020 and March 2021 are broadly similar – a return to an economy characterised by large and persistent sector imbalances, with combined public and private sector deficits and an increasing reliance on the RoW as a net lender.
This scenario is as unsustainable post-COVID as it was pre-COVID, and leaves the reader wondering about the value of official forecasts in presenting an accurate outlook for the future financial interactions between the key UK economic agents.
Please note that the summary comments and chart above are extracts from more detailed analysis that is available seperately. Please also note that subsequent posts will dig out the “hidden value”!
What to look for in the OBR’s forecasts (and where)
The key chart (from November 2020)
The chart that said so much last November – historic and forecast trends in financial sector balances for the UK private sector, UK government and RoW expressed as % GDP (Source: OBR; CMMP)
The key message
The Office for Budget Responsibility (OBR) will publish its latest forecasts in their “Economic and fiscal outlook – March 2021”, alongside the Chancellor’s budget tomorrow (3 March 2021)
The report is typically over 200 pages long and contains much detailed work, analysis and scenario planning. Very helpfully, it also includes one page (typically around page 65/66) that gives the reader immediate insights into the reliance and/or confidence that can be placed on the rest of the forecasts. The page is headed, “sectoral net lending” and, as the name suggests, links directly to CMMP’s preferred financial sector balances framework.
In November last year, this page illustrated clearly the risks to the rest of the OBR’s forecasts for UK growth and for the level of government borrowing. First, they assumed unprecedented levels of dynamism from both the UK household and corporate sectors and behavioural trends from these sectors and from the RoW that contrasted sharply with those seen after the GFC. Second, while they claimed that “sectoral net lending positions return to more usual levels,” this did not make them sustainable.
It is unusual, but equally very helpful, that one page can tell us so much about the truth behind the headlines that will dominate tomorrow’s news and Thursday’s papers…
The biggest fail so far – money and credit cycles diverge even further in January 2021 (Source: BoE; ECB; CMMP)
Tke key message
Investors waiting in anxious anticipation for reflationary messages from the money sector will require some patience yet.
January 2020’s money supply data shows that households (HHs) in the UK and euro area (EA) continue to increase their holdings of liquid assets, money and credit cycles are diverging even further (to new highs), and consumer credit remains very weak. In other words, behind the headline figures, rising money supply in both regions remains a function of deflationary rather than inflationary forces – elevated HH uncertainty, relatively subdued demand for credit, and weak HH consumption. The drivers and implications of rapid money growth in the UK and the EA are very different from past cycles. Behind the headlines, and with three fails so far, the message from the UK and EA money sectors remains the same – “not so fast”.
Three key signals – January 2021
Fail #1 – monthly flows in HH money holdings expressed as a multiple of 2019 average monthly flows (Source: BoE; ECB; CMMP)
HHs in the UK and the EA continue to increase their holdings of highly liquid assets. In response to the COVID-19 pandemic, the levels of forced and precautionary savings have risen sharply. Today’s (1 March 2021) data release from the BoE, shows UK HHs increasing their money holdings by £18.5bn in January 2021, 4x the average monthly flows recorded in 2019. This is despite the fact that the effective interest rate paid on new time deposits remains at the lowest level (0.42%) since the series began. As noted, in my previous post, January’s monthly flows of HH deposits in the EA (€60bn) also remained almost 2x their 2019 average.
Money sitting idly in savings accounts contributes to neither GDP nor inflation.
Fail #2 – the gap between the money and credit cycles have widened to new record levels (Source: BoE; ECB; CMMP)
Rather than re-synching with each other, money and credit cycles in both regions widened to historic degrees in January 2021. The gap between the YoY growth in UK money (15.0%) and lending (4.4%) widened to a record 10.6ppt in January, while the gap between EA money (12.5%) and lending (4.4%) widened to 8.1ppt. Credit demand remains relatively subdued in both regions, despite the low cost of borrowing, while money supply has accelerated.
Fail #3 – growth rates (% YoY) of consumer credit in the UK and EA (Source: BoE; ECB; CMMP)
Consumer credit growth remains very weak. In the UK, HHs made net repayments of consumer credit of £2.4bn, the largest repayment since May 2020. The annual growth rate of -8.9% is yet another series low since the series began in 1994. Similarly, the -2.5% fall in consumer credit in the EA was the weakest level since February 2014.
Note that consumer credit represents one section of more productive COCO-based lending. It supports productive enterprise since it drives demand for goods and services, hence helping NFCs to generate sales, profits and wages. As before, with HHs hoarding cash and lockdown measure remaining in place, this weakness in consumer credit is not unexpected.
Conclusion
I have explained previously that the drivers and implications of rapid money supply growth in the UK and the EA are very different from past cycles and that the message from the money sectors in both regions for investors positioned for a sustained rise in inflation was, “not so fast.” The message from January’s data releases remains the same. Patience, patience…
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
And the trends that investors SHOULD be looking for…
The key chart
Growth rates (% YoY) in UK and EA broad money aggregates (Source: BoE; ECB; CMMP)
The key message
Should investors positioned for an upturn in inflation and sustained outperformance from cyclical and value plays and/or shorter duration trades be hoping for stronger or weaker money supply growth in the UK and EA in 2021?
Contrary to the popular narrative, the answer is likely to be the latter not the former. In this post, I summarise why this is the case and highlight the three key charts to follow in 2021.
Over the past decade, we have witnessed a sustained shift in the components of broad money supply (M3) with greater contribution coming from holdings of the most liquid assets ie, narrow money (M1). The reaction of UK and EA households to the COVID-19 pandemic has accelerated this trend, as levels of forced and precautionary savings have risen sharply, particularly in the UK.
The challenge for inflation hawks here is that money sitting idly in savings accounts contributes to neither GDP nor inflation.
Analysis of the counterparts of monetary aggregate highlights the extent to which money and credit cycles are diverging in both regions. Within subdued overall levels of private sector credit demand, relatively robust NFC credit and resilient mortgage demand offset weakness in consumer credit during 2020. Weakness in consumer credit was more noticeable in the UK, where net repayments of £17bn made 2020 the weakest year for consumer credit on record.
There are three key signals among the messages from the money sector in 2021 to look for:
First, a moderation in monthly deposit flows
Second, a re-synching of money and credit cycles
Third, a recovery in consumer credit.
Trends in 2020, suggest that the UK has a relatively high gearing to each of these trends.
The charts that mattered in 2020
Share of narrow money in UK and EA broad money since 2010 (Source: ECB; BoE; CMMP)
Over the past decade, we have witnessed a sustained shift in the components of broad money supply (M3) with greater contribution coming from holdings of the most liquid assets ie, narrow money (M1). At the end of 2010, M1 accounted for 46% and 51% of M3 in the UK and EA respectively. By the end of 2020, these shares had risen to 67% and 71% respectively (see chart above).
In other words, changes in holdings of notes and coins and overnight deposits are having a greater impact on the behaviour of money supply. As noted in, “The yawning gap”, for example, M1 contributed 10.7ppt to the 12.3% growth in EA M3 in 2020.
Monthly flows of HH money in the UK (Source: BoE; CMMP)
The reaction of UK and EA households to the COVID-19 pandemic has accelerated this trend, as levels of forced and precautionary savings have risen sharply.
The first COVID-related death in the UK was recorded on 5 March 2020 and the first lockdown began 18 days later on the 23 March 2020. UK households increased their money holdings by £14bn, £17bn and £27bn in March, April and May 2020 respectively. This £58bn increase in holdings was greater than the total flow of £55bn recorded in 2019. Households began to increase then money holdings sharply again in October 2020, even though the second lockdown did not come into effect until 5 November 2020. In the last three months, UK households increases their money holdings by £13bn, £18bn and £21bn (£52bn in total), 3-4x the average monthly flows in 2019 (see chart above).
Monthly flows of HH deposits in the EA (Source: ECB; CMMP)
Similar household behaviour was seen in the euro area albeit with slightly different timings and scale. In the early stage of the pandemic, household deposits increased by €78bn and €75bn in March and April 2020 respectively, more than double the average 2019 monthly flows. In November and December 2020, monthly flows increased again to €61bn and €53bn (see chart above).
The challenge for inflation hawks here is that money sitting idly in savings accounts contributes to neither GDP nor inflation.
Growth in private sector credit minus growth in money supply in the UK and EA (Source: BoE; ECB; CMMP)
Analysis of the counterparts of monetary aggregate highlights the extent to which money and credit cycles are diverging in both regions. As noted last month, in typical cycles, monetary aggregates and their key counterparts move together. Money supply indicates how much money is available for use by the private sector. Private sector credit indicates how much the private sector is borrowing.
At the end of 2019, the gap between the growth in lending and the growth in money supply was 0.6ppt and -2ppt in the UK and EA respectively. By the end of 2020, these gaps had widened to record levels of -9.9pt and -7.6ppt (see chart above). Simply put, credit demand has remained relatively subdued in both regions, despite the low cost of borrowing, while money supply has accelerated.
Trends in NFC credit, mortgages and consumer credit since 2018 (Source: BoE; ECB; CMMP)
Within subdued overall levels of private sector credit demand, relatively robust NFC credit and resilient mortgage demand offset weakness in consumer credit during 2020 in both regions (see chart above). The YoY growth in NFC credit in the UK increased from 3.3% in 2019 to 7.7% in 2020. Similarly, the respective growth rates in the EA increased from 3.2% in 2019 to 7.0% in 2020. Mortgage growth in the UK moderated slightly from 3.4% in 2019 to 3.0% in 2020 but rose from 3.9% in 2019 to 4.7% in 2020 in the EA. Consumer credit grew 6.1% and 6.0% in the UK and EA in 2019 respectively, but fell 7.5% and 1.6% in 2020 respectively.
2020 monthly trends in HH consumer credit in the UK (Source: BoE; CMMP)2020 monthly trends in HH consumer credit in the EA (Source: ECB; CMMP)
The weakness in consumer credit was more significant in the UK than in the EA. Net repayments of £17bn made 2020 the weakest year for consumer credit on record. UK households repaid consumer credit in the last four months of 2020 and the annual growth rate of minus 7.5% represented the weakest rate of growth since the series began in 1994 (see first of the charts above). EA households also repaid consumer credit in three of the last four months of 2020, but the YoY decline of minus 1.6% was more moderate than in the UK.
Conclusion and three charts to watch in 2021
A sustained upturn in inflation and outperformance from cyclical and value sectors and shorter duration trades will require confidence, consumption and investment to return fully. There are three key signals to look for in the messages from the UK and EA money sectors in 2021.
Monthly deposit flows as a multiple of the 2019 monthly average (Source: BoE; ECB; CMMP)
First a moderation in monthly deposit flows, especially by the household sector, and slower growth in narrow money (M1) and hence broad money (M3).
The yawing gap between money supply and private sector credit demand (Source: BoE; ECB; CMMP)
Second, a re-synching of money and credit cycles with a corresponding rebalancing in the counterparts of broad money growth.
Trends in YoY growth rates for UK and EA consumer credit (Source: BoE; ECB; CMMP)
Third, and finally, a recovery in consumer credit. Consumer credit represents one section of COCO-based lending (see “Fuelling the FIRE”). Its supports productive enterprises since it drives demand for goods and services, hence helping NFCs to generate sales, profits and wages.
The relative scale in the shift of money holdings and weakness in consumer credit suggests that the UK has a higher gearing than the EA to a reversal of 2020’s COVID-19 induced dynamics. Watch this space in 2021…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Positive volume trends (outstanding balances, monthly flows, YoY growth) for UK mortages in 4Q2020 (Source: BoE; CMMP)
The key message
UK mortgages provide some relative cheer among otherwise downbeat messages from the money sector:
Individuals borrowed £5.6bn in the form of mortgages in December 2020, unchanged from November, while repaying £1.0bn in consumer credit.
Quarterly flows (£15.9bn) in 4Q2020 were the highest since 1Q2008.
Despite this strong recovery, mortgage borrowing in 2020 (£43.3bn) was lower than in 2019 (£48.1bn) and current demand remains subdued in relation to previous cycles.
Looking forward, mortgage approvals (103,400) were the second highest since August 2007, and suggest positive future volume trends.
The effective interest rate on new mortgages rose 7bp in December to 1.9%, the highest rate since October and the spread between this and the rate on the outstanding stock narrowed to 22bp, from 55bp in February 2020.
Among mortgage providers, the sector winners are not simply riding these trends but are also increasingly embracing digitalisation across operations, sales, finance and risk management to differentiate themselves and improve the experience for their members.
The six charts that matter
Monthly flows in UK retail lending (£bn) for 2020 (Source: BoE; CMMP)
The UK mortgage market continues to provide some relative cheer among otherwise downbeat messages from the money sector (see chart above). Individuals borrowed an additional £5.6bn in the form of mortgages in December 2020, broadly unchanged from November. In contrast, households repaid £1.0bn in consumer credit, having repaid £1.5bn, £0.6bn and £0.8bn in the three preceding months.
UK mortgage volumes “bounced back” strongly from 2Q low (Source: BoE; CMMP)
Quarterly mortgage flows totalled £15.9bn in 4Q20 compared with £11.1b, £3.8bn and £12.5bn in the three preceding quarters respectively. As can be seen in the chart above, this was the largest quarterly flow in the past five years and the largest since 1Q2008.
But real growth remains subdued in relation to past cycles (Source: BoE; CMMP)
Despite this strong recovery, however, total 2020 mortgage borrowing of £43.3bn was below 2019’s total of £48.1bn. Current mortgage demand also remains subdued in relation to past cycles (see chart above). In real terms, the 3-month MVA for mortgage demand was only 2.3% in December 2020, essentially stable real growth over the 2H2020
Trends in approvals for house purchases (Source: BoE; CMMP)
.Looking forward and more positively, mortgage approvals, which have proved a reliable indicator of future lending, were 103,400 in December, the second highest level since August 2007 (see chart above), and totalled 818,500 in 2020, the largest yearly number since 2007.
Effective interest rates on new mortgages and on the outstanding stock (Source: BoE; CMMP)
The effective interest rate on new mortgages rose 7bp in December to 1.9%, the highest rate since October 2019 (see chart above). This rate remains below the rate on the outstanding stock of mortgages (2.12%) but the spread between the two effective rates has narrowed to 22bp from 55bp in February 2020 (see chart below).
Downward pressure on NIMs starting to ease? (Source: BoE; CMMP)
Among mortgage providers, the sector winners are not simply riding these trends but are also increasingly embracing digitalisation across operations, sales, finance and risk management to differentiate and improve the experience for their members.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
FIRE- vs COCO-based lending – a cross-EA comparison
The key chart
The balance between FIRE- and COCO-based lending in the six largest EA banking markets (Source: ECB; CMMP)
The key message
In “Fuelling the Fire, Part II”, I stressed the importance of distinguishing between different forms of credit. I made the contrast between productive, “COCO-based” credit and less-productive, “FIRE-based” credit, highlighted the shift towards greater levels of FIRE-based lending in the euro area (EA), and noted the negative implications of this trend for leverage, growth, financial stability and income inequality in the EA.
In this short, follow-on post, I add details on how the balance between these forms of credit differs between the largest EA banking sectors (NL/BE vs ES/IT) and across the EA as a whole. For interest, I also note an adaptation of Hyman Minsky’s hypothesis that states that over the course of a long financial cycle, there will be a shift towards riskier and more speculative sectors and discuss its application to EA banking briefly.
FIRE-based versus COCO-based lending across the EA
The balance between FIRE-based and COCO-based lending varies across the EA. Among the six largest banking sectors that account for just under 90% of total EA credit, FIRE-based lending ranges from 64% of total credit in the Netherlands to 43% in Italy (see the key chart above). Across the 19 EA economies, the low end of this range extends down to 40% in Slovakia and Greece, and Ireland joins the Netherlands and Belgium with a relatively high share of FIRE-based lending (see chart below).
The wider picture across the 19 EA member states (Source: ECB; CMMP )
Interestingly, in the Netherlands and Belgium, the two large economies with the highest share of less-productive FIRE-based lending, the NFC debt ratios are both 159% of GDP, well above the BIS threshold level of 90%. In both cases, the NFC sectors are deleveraging with debt ratios falling from peaks of 179% of GDP in the Netherlands (1Q15) and 171% of GDP in Belgium (2Q16).
Trends in NFC debt ratios (%GDP) in the Netherlands and Belgium (Source: BIS; CMMP)
The HH dynamics are very different however, re-enforcing the message that the EA money sectors are far from a homogenous group! In the Netherlands, for example, the HH sector has also been deleveraging since the 3Q201 when the debt ratio hit 121%. In contrast, HH leverage is increasing in Belgium, with the debt ratio hitting a new high (albeit a relatively low one) of 65% in 2Q20.
Trends in HH debt ratios (% GDP) in the Netherlands and Belgium (Source: BIS; CMMP)
The high levels of HH and NFC debt in the Netherlands has stimulated much research. Dirk Bezemer at the University of Groningen, for example, has studied the impact of these trends and the extent to which the financial sector helps, hurts or hinders the wider economy. His research builds on Hyman Minksy’s theory and the idea that over the course of a long financial cycle, investors will shift towards riskier and more speculative investments.
The 2008 crisis demonstrated that the Netherlands behaved in line with Minsky’s insights. It proved very vulnerable indeed to financial shocks. The country also experienced a stagnation in economic growth which was unusually long in international comparison.
Dirk Bezemer, “Why Dutch debt tells us economic growth may be fragile” 2017
Bezemer argues that Minksy’s theory can be applied to data on credit trends with “Minsky’s shift” being reflected in the decline in bank credit to the real sector (COCO-based credit) and an increase in funds flowing towards property and financial asset markets (FIRE-based credit). There are many similarities between Bezemer’s arguments and the trends highlighted in CMMP analysis. Please contact me for details.
CAGR in credit versus CAGR in nominal GDP (rolling, three years) in France (Source: BIS; CMMP)
That said, there are always exceptions to the rule. In France, for example, FIRE-based and COCO-based lending are more balanced (52%:48%) with the later growing strongly despite the fact that the NFC debt ratio hit a new high of 167% of GDP in the 2Q20.(This is the highest NFC debt ratio in this sample.) Over the past three years, the CAGR in HH and NFC credit in France has exceeded the CAGR in GDP by 4.4ppt and 5.4ppt respectively (see chart above), highlighting the fact that banking risk comes in many, different forms…
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
What are the implications of the widening divergence between money and credit cycles?
The key chart
The widening gap between growth in lending and growth in money supply (Source: ECB; Bank of England; CMMP analysis)
The key message
Current money cycles in the EA and UK, (1) differ from previous cycles in terms of their drivers and implications, (2) are out-of-synch with the respective credit cycles, and (3) diverging from credit cycles at historically rapid rates. The implications here for growth, inflation, policy choices, investment returns and asset allocation are missing from many recent “2021 Investment Outlooks”.
Is it wise to ignore the “messages from the money sector”?
This week’s data releases show broad money growing at the fastest rate in the current money cycle in both the EA (11.0%) and the UK (13.9%). What is this telling us?
Households are increasing their money holdings at 2-4x the average 2019 monthly rate, delaying consumption and repaying existing consumer credit with negative implications for economic growth and inflation.
In terms of policy choices, monetary policy effectiveness requires stable relationships between monetary aggregates, but these are increasingly absent. The gap between growth rates in money supply and private sector credit demand is at record highs in both regions – one more reason to add to the list of why the required policy response is, “fiscal, first and foremost.”
For some, rising money supply suggests higher inflation in the EA and the UK and supports asset allocation shifts towards cyclical and value plays and shorter duration trades. The message from the money sector with elevated uncertainty, low confidence, weak consumption and subdued credit demand is, “not so fast.”
The charts that matter
Growth trends in EA and UK broad money aggregates in % YoY (Source: ECB; Bank of England; CMMP analysis)
This week’s ECB and Bank of England data releases show broad money growing at the fastest rate in the current money cycle in both the EA and the UK (see chart above). M3 in the EA grew 11.0% YoY in November 2020, up from 10.5% in October. M4ex in the UK grew 13.9% YoY in November 2020, up from 13.2%.
To understand what these trends are telling us, and to understand how the current money cycle differs from previous cycles, we need to examine both the components and counterparts to broad money rather than focus simply on the headline numbers.
Growth in M3 (% YoY) and contribution of M1 (ppt) to total growth (Source: ECB; CMMP analysis)
From a components perspective, we can see that growth in narrow money i.e. notes and coins in circulation and, more importantly, overnight deposits is the key driver of overall money growth (see chart above). In the EA, for example, M1 grew at 14.5% YoY and contributed 9.9ppt to the 11.0% YoY growth in M3. Overnight deposits grew 15.0% YoY and contributed 8.9ppt to the total growth alone.
Share of narrow money (M1) in broad money (M3) since 2000 (Source: ECB; Bank of England; CMMP analysis)
Recent trends are an extension/acceleration of longer-term secular shifts in the composition of EA and UK money supply (see chart above). Twenty years ago, M1 accounted for 42% and 48% of M3 in the EA and UK respectively. The shares were the same at the height of the GFC in 2008. Today, however, M1 accounts for 71% and 68% of M3 in the EA and the UK respectively. This increase in liquidity preference/money holdings reflects an increasingly lower opportunity cost of holding money as rates have fallen and, more recently, a sharp rise in both forced and precautionary savings by the regions’ households.
Households are increasing their money holdings at 2-4x the average 2019 monthly rate, delaying consumption and repaying existing consumer credit with negative implications for economic growth and inflation. In the EA, household money holdings increased by EUR61bn in November, almost double the average flow of EUR33bn recorded during 2019 (see chart above). This reflects similar, albeit more volatile, trends in the UK highlighted in, “And now, the not-so-good-news” and to repeat the message in that post – money sitting in savings accounts does not contribute to GDP or higher inflation.
Trends in monthly consumer credit flows and YoY growth rate (Source: ECB; Bank of England)
EA households are not only delaying consumption, they are also repaying existing consumer credit. In November 2020, net repayments totalled EUR4bn, the largest amount since the peak of the first wave of the pandemic in April. On a YoY basis, consumer credit declined by 1.1%, the weakest level in the current slowdown (see chart above). In the UK, households repaid consumer credit for three consecutive months between September and November 2020 and YoY declines are the weakest since records began.
Repeating the key chart – the widening gap between growth in lending and growth in money supply (Source: ECB; Bank of England; CMMP analysis)
In terms of policy choices, monetary policy effectiveness requires stable relationships between monetary aggregates, but these are increasingly absent. The gap between growth rates in money supply and private sector credit demand is at record highs in both regions. In the EA, the gap between the supply of money (11.0%) and private sector demand for credit (4.7%) was 6.3ppt. In the UK, money supply grew 13.9%, 9.4ppt faster than private sector credit demand. This is one more reason to add to a lengthening list of why the required and sustained policy response should be, “fiscal, first and foremost.” In my next post, I will up-date my analysis to add another factor to this list i.e. credit is increasingly shifting towards less productive sectors of the economy (see also “Fuelling the FIRE – the hidden risk in QE“).
A preview of the theme in my next post – COCO-based versus FIRE-based lending (Source: ECB; CMMP analysis)
Conclusion
What does this all mean? (Source: ECB; Bank of England; CMMP analysis)
For some, rising money supply suggest higher inflation in the EA and the UK, and supports asset allocation shifts towards cyclical and value plays and shorter duration trades. The message from the money sector remains, “not so fast.”
One of my favourite current charts! Growth in M3 and contribution of M1 and PSC. (Source: ECB; CMMP analysis)
CMMP analysis of the components and counterparts of broad money tell a very different story from previous money cycles. The EA and UK money sectors are consistent signalling elevated uncertainty, low confidence, weak consumption and subdued credit demand – even before the introduction of further, more stringent lock-down policies in January 2021.
If there is a positive interpretation of current trends, it is that there is a large element of forced savings and hence pent-up consumer demand. That is true, but history also tells us that households and corporates can take time to adjust to major economic shocks and caution us against expecting a rapid reversal in confidence and consumption.
Please note that the summary comments above are extracts from more detailed analysis that is available separately
Trends in UK mortgages during 2020 -balances, monthly flow and YoY growth rates (Source: Bank of England, CMMP analysis))
The key message
The Bank of England’s latest “Money and Credit” release (4 January 2021) provides three positive data points for UK mortgage providers. First, households borrowed £5.7bn secured on their homes in November 2020, the highest level since March 2016. Second, mortgage approvals are at their highest level (105,000) since August 2017, suggesting positive future lending trends. Third, the effective rate on new mortgages increased a further 5bp in November to 1.83%, up from August’s low of 1.72%.
That said, mortgage demand remains very subdued in relation to historic trends and rates on new lending continue to act as a drag on revenues generated from outstanding mortgage balances.
As noted, back in October and December 2020, this is no time for mortgage providers to relax despite these positive developments. The winners in 2021 and beyond will be those providers who accelerate digitalisation across operations, sales and finance and risk to differentiate themselves and improve the experience for their members.
Six charts that matter
Worth repeating the key chart again! (Source: Bank of England; CMMP analysis)
UK households borrowed £5.7bn secured on their homes in November 2020, the highest level of monthly borrowing since March 2016. November’s monthly flow compares with average monthly borrowings of £4bn in 2019 and £2.7bn in 1H2020. The YoY growth rate in mortgages rebounded slightly to 2.9%, above the recent lows of 2.7% YoY recorded in August and October 2020.
Looking forward – trends in approvals for house purchases since 2007 (Source: Bank of England; CMMP analysis)
Mortgage approvals in November – an indicator for future lending – hit the highest level since August 2007. Approvals for house purchases increased to 105,000 from 98,300 in October and the 2020 low of 9,349 in May. In its commentary, the Bank of England noted that, “recent strength in approvals has almost fully offset the significant weakness earlier in the year.”
Trends in the effective rate on new mortgages (Source: Bank of England; CMMP analysis)
The effective rate on new mortgages (the actual interest rate paid) increased a further 5bp in November to 1.83%, up from August’s low of 1.72%. This rate is, however, still down 4bp YoY and 5bp YTD. The rate on the outstanding stock of mortgages was slightly lower at 2.11% in November (a new low).
Monthly flows (£bn) in lending to UK individuals (Source: Bank of England, CMMP analysis)
Resilient mortgage demand is the one bright spot in an otherwise gloomy UK retail lending market. Total lending to individuals grew by only 1.6% YoY, despite the 2.9% growth in mortgage lending. The annual growth rate in consumer credit fell to -6.7% in November, another series low. Since the beginning of March, UK consumers have repaid over £17bn in consumer credit.
UK mortgage lending since 2000 (Source: Bank of England; CMMP analysis)
That said, current mortgage demand remains very subdued in relation to past cycles (see graph above). Real YoY growth rate in mortgage has averaged only 2.2% YoY during 2020. This compares with an average real growth rate in excess of 9% YoY between November 2000 and November 2008.
Effective interest rates on new mortgages and the outstanding stock (Source: Bank of England; CMMP analysis)
The 28bp gap between the effective rate on new mortgage lending (1.83%) and the effective rate on the outstanding stock of mortgages (2.11%) is relatively narrow in relation to recent trends but on-going pressure on NIMs and revenue growth remains a key challenge for the sector.
Conclusion
As noted, back in October and December 2020, however, this is no time for mortgage providers to relax despite the positive developments noted above. The winners in 2021 and beyond will be those providers who accelerate digitalisation across operations, sales and finance and risk to differentiate themselves and improve the experience for their members.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Banks may deliver poor LT investment returns but their interaction with the wider economy provides important insights for corporate strategy, investment returns and asset allocation (#1).
Starting from a simple understanding of core banking services, we can build a quantifiable, objective and logical analytical framework linking all domestic sectors with each other and with the rest of the world (#2).
This framework allows us to challenge official UK forecasts that assume unprecedented behaviour and dynamism from UK households and corporates in support of unsustainable outcomes (#3).
It also allows us to debunk EA myths and identify the key factors that will determine the shape of any recovery in Europe and investment returns in 2021 (#4).
The messages from the UK and EA money sectors during the pandemic have been very similar, albeit with the UK demonstrating higher gearing to current dynamics, including any return to normality (#5).
They also contrast sharply with the messages associated with previous periods of monetary expansion (#6).
Finally, humility and a willingness to unlearn the so-called lessons of the past is important, especially in relation to banking and macroeconomics. The outlook for 2021 will depend, largely, on whether policy makers are willing to challenge orthodox fiscal thinking (#7).
Humility and the willingness to unlearn the lessons of the past
Lesson #7
The final lesson is the importance of humility and a willingness to unlearn the lessons of the past, especially in relation to banking and macroeconomics. It is, after all, only six years since the Bank of England debunked the widely taught and held view that banks act simply as intermediaries, lending out deposits that savers place with them.
In the current context of large-scale fiscal responses to the pandemic, its will be important to see how other (so-called) lessons from the past are treated e.g. governments should budget like households, governments spend taxpayers money, deficits are evidence of over-spending/crowding out of the private sector, Chancellors have moral duties to balance the books etc.
The shape and duration of any recovery and investment returns in 2021 will depend, for example, on whether the notion that fiscal expansion is indispensable to sustain demand is fully understood or not (#4). Will 2020-21 be a watershed moment in macro understanding/policy?
In this context, I am ending this series of summary posts with a link to a recent article published by David Andolfatto of the Federal Reserve Bank of St Louis on 4 December 2020. This important article may foreshadow a shift in macro policy understanding. In line with my preferred financial sector balances approach (#2), Andolfatto questions the “government as a household” analogy and also notes that, to the extent that government debt is held domestically, it constitutes wealth for the private sector. From here, and more significantly, he argues that:
“…it seems more accurate to view the national debt less as a form of debt and more as a form of money in circulation…The idea of having to pay back money already in circulation makes little sense, in this context. Of course, not having to worry about paying back the national debt does not mean there is nothing to be concerned about. But if the national debt is a form of money, wherein lies the concern?”
“Does the National Debt Matter?” Federal Reserve Bank of St. Louis, December 2020
Wherein indeed? Delicious food-for-thought for the Festive Season and for 2021…
