Category: UK

“Europe versus the UK”

How do the messages from the money sectors compare?

The key chart

Broad money growth is accelerating in both regions, but how do the messages behind these trends compare and what do they mean? (Source: ECB; Bank of England; CMMP analysis)

The key message

Broad money growth is accelerating in both the euro area (EA) and the UK but how do the messages behind these trends compare and what do they mean for investors?

M1 dynamics are the key growth drivers here as EA and UK households and corporates maintain high preferences for holding liquid assets despite negative real returns. Above trend corporate credit and resilient mortgage demand is offsetting weakness in consumer credit in both regions but with more volatile YoY credit dynamics in the UK. The growth gap between the supply of money and the demand for credit has reached new 10-year highs.

The overriding message here is one of uncertainty and deficient credit demand, a more nuanced message than some inflation hawks suggest.

Looking at ST dynamics, uncertainty peaked in May in both regions, HHs have stopped repaying consumer credit and the NFC “dash-for-cash” has also peaked.

From an investment perspective, 2020 is seen best as a year when an extreme event (Covid-19) engulfed weak, pre-existing cyclical trends. The negative impacts of this event have peaked, at least from a monetary perspective. However, adverse (over-arching) LT structural dynamics that have their roots in excess levels of private sector debt remain with negative implications for money, credit and business cycles and future investment returns.

The charts that matter

The key chart above illustrates how growth in broad money (M3) is accelerating in both the EA and UK. In the EA, M3 grew 10.2% in nominal and 9.8% terms YoY in July, the highest rates of growth since May 2008 and July 2007 respectively. In the UK, M3 grew 11.9% in nominal and 10.8% in real terms in July, the highest rates of growth since April 2008 and June 2008 respectively (n.b. I am using M3 here for comparison purposes rather than the Bank of England’s preferred M4ex measure referred to in other posts). These trends have helped to ignite the “inflation versus deflation” debate which, in turn, requires investigation of trends in the components and counterparts of broad money growth.

M1 is playing an increasing role in M3 in the EA and the UK despite negative real returns from overnight deposits (Source: ECB; Bank of England; CMMP analysis)

From a components perspective, narrow money (M1) is playing an increasing role in this growth despite negative real returns as EA and UK households (HHs) and corporates (NFCs) maintain high preferences for liquid assets. In the EA, M1 now accounts for 70% of M3 compared with only 42% twenty years ago. In the UK, M1 now accounts for 65% of M3 versus only 48% twenty years ago (see chart above). In both cases, the share of narrow money in broad money is at a historic high – potentially negative news for inflation hawks as HH and NFCs continue to save in the face of high uncertainty levels. The key unknown here is the extent to which these savings are forced or precautionary. Forced savings can be released relatively quickly to support economic activity. In contrast, precautionary savings are unlikely to move straight into investment or consumption.

Similar NFC, mortgage and consumer credit trends but with more volatile YoY growth dynamics in the UK (Source: ECB; Bank of England; CMMP analysis)

From a counterparts perspective, above trend NFC credit and resilient HH mortgage demand is offsetting weakness in consumer credit, with the UK demonstrating more volatile YoY growth dynamics than the EA. The graph above illustrates YoY growth trends in NFC credit (green), mortgages (blue) and consumer credit (red) for the EA (dotted lines) and the UK (full lines) over the past 5 years.

NFC credit is growing well above trend in both regions, but below May’s recent peak levels. In the EA, NFC credit grew 7.0% in July versus 7.3% in May. In the UK, NFC credit grew 9.6% in July versus 11.2% in May. Mortgage demand has remained resilient in both regions growing 4.2% in the EA and 2.9% in the UK. Weakness in consumer credit appears to be stabilising (see monthly trends below). In the EA consumer credit grew 0.2% in July unchanged from June, but still a new low YoY growth rate. In the UK, consumer credit declined -3.6% YoY compared with a decline of -3.7% in June.

Counterparts versus components – new peak gaps in the growth of private sector credit and money supply (Source: ECB; Bank of England; CMMP analysis)

Diverging trends between the components and counterparts of broad money tell an important story – the gap between the growth in money supply and the growth in credit demand is at new 10-year peak levels. In the EA, the gap between M3 growth (10.2%) and adjusted loans to the PSC growth (4.7%) was 5.5ppt (or minus 5.5ppt in the graph above). This is a 10-year peak and the largest gap since 2001 (not shown above). In the UK, the gap between M4ex growth (12.4%) and M4Lex (5.5%) was 6.9ppt, again a new 10-year peak. In “normal cycles”, money supply and the demand for credit would move together but current trends are indicative of a basic deficiency in credit demand and a second potentially negative piece of news for inflation hawks.

Uncertainty proxies for EA HHs and NFCs (Source: ECB; CMMP analysis)

Looking at ST dynamics, “uncertainty” appears to have peaked at the same time (May 2020) in both the EA and the UK but remains very elevated against historic trends. In this context, trends in monthly flows into liquid assets offering negative real returns are used a proxy measure for uncertainty. In July, deposits placed by EA HHs totalled €53bn, below April 2020’s peak of €80bn but still above the 2019 average monthly flow of €33bn. NFC deposits increased by €59bn in July. Again this was below May 2020’s peak flows of €112bn but still well above the 2019 average monthly flow of €13bn (see chart above).

Uncertainty proxies for UK HHs and NFCs (Source: Bank of England; CMMP analysis)

In the UK, HH deposit flows totalled £7bn in July, down from the May 2020 peak of £27bn but above the 2019 monthly average flow of £5bn. NFCs deposits in July rose from £8bn in June to £ 12bn in July. These were also below the May 2020 peak of £26bn but well above the £0.8bn 2019 average (see chart above).

Monthly consumer credit flows in the EA (Source: ECB; CMMP analysis)

HHs have stopped repaying consumer credit and monthly flows have bounced back to just below (EA) or just above (UK) 2019 monthly average. In July, EA consumer credit totalled €3.2bn and €3bn in June and July respectively. This followed repayments of €-12bn, €-14bn and €-2bn in March, April and May respectively. The last two months’ positive monthly flows compare with the 2019 average of €3.4bn.

Monthly consumer credit flows in the UK (Source: Bank of England; CMMP analysis)

After four consecutive months of net repayments, UK consumer credit turned positive in July. The £1.2bn borrowed in July was above the average £1.2bn recorded in 2019. As noted above, the recent weakness in consumer credit means that the average growth rate (-3.6% YoY) is still the weakest since the series began in 1994.

Conclusion

In “August snippets – Part 1”, I highlighted the importance of disciplined investment frameworks and followed this in “August snippets – Part 2” by revisiting the foundations of my CMMP Analysis framework that incorporates three different time perspectives into a single investment thesis. How do July’s trends fit into this framework?

The overriding message here is one of uncertainty and deficient credit demand, a more nuanced message than some inflation hawks suggest. Looking at ST dynamics, uncertainty peaked in May in both regions, HHs have stopped repaying consumer credit and the NFC “dash-for-cash” has also peaked. From an investment perspective, 2020 is seen best as a year when an extreme event (Covid-19) engulfed weak, pre-existing cyclical trends. The negative impacts of this event have peaked, at least from a monetary perspective. However, the negative (over-arching) LT structural dynamics that have their roots in excess levels of private sector debt remain with negative implications for money, credit and business cycles and future investment returns.

If you go down to the woods today…

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

“August Snippets – Part 2”

Revisiting the foundations of CMMP analysis

The key message

In “August snippets – Part 1”, I highlighted the importance of disciplined investment frameworks. In this second snippet, I revisit the foundations of my CMMP Analysis framework. I start by describing how I combine three different time perspectives into a consistent investment thesis (“three pillars”). I then explain how the core banking services (payments, credit and savings) link different economic agents over time to form an important fourth pillar – financial sector balances. Finally, I present examples of how these four pillars combine to deliver deep insights into policy options and responses.

The central theme is my belief that the true value in analysing developments in the financial sector lies less in considering investments in banks but more in understanding the implications of the relationship between banks and the wider economy for corporate strategy, investment decisions and asset allocation.

Three perspectives – one strategy

  • As an investor, I combine three different time perspectives into a single investment strategy
  • My investment outlook at any point in time reflects the dynamic between them
  • My conviction reflects the extent to which they are aligned

Pillar 1: Long-term investment perspective

Example chart 1: growth trends in PSC illustrate how global finance is shifting East and towards emerging markets ($bn) (Source: BIS; CMMP analysis )

My LT investment perspective focuses on the key structural drivers that extend across multiple business cycles. Given my macro and monetary economic background, I begin by analysing the level, growth, affordability and structure of debt. These four features of global debt have direct implications for: economic growth; the supply and demand for credit; money, credit and business cycles; policy options; investment risks and asset allocation. My perspective here reflects my early professional career in Asia and experience of Japan’s balance sheet recession. The three central themes are (1) global finance continues to shift East and towards emerging markets, (2) high, “excess HH growth rates” in India and China remain a key sustainability risk, and (3) progress towards dealing with the debt overhang in Europe remains gradual and incomplete. The following four links provide examples of LT investment perspectives:

Example chart 2: China’s HH debt ratio continued to rise sharply in 1Q20 – too much, too soon? (Source: National Bureau of Statistics; CMMP analysis)

Pillar 2 – Medium-term investment perspective

Example chart 3: growth rates in M1 and private sector credit demonstrate robust relationships with the business cycle through time and have proved more reliable indicators of recessions risks than the shape of the yield curve (Source: ECB; CMMP analysis)

My MT investment perspective centres on: analysing money, credit and business cycles; the impact of bank behaviour on the wider economy; and the impact of macro and monetary dynamics on bank sector profitability. Growth rates in narrow money (M1) and private sector credit demonstrate robust relationships with the business cycle through time. My interest is in how these relationships can assist investment timing and asset allocation. My investment experience in Europe shapes my MT perspective, supported by detailed analysis provided by the ECB. A central MT theme here is the fact that monetary developments: (1) have proved a more reliable indicator of recession risks than the shape of the yield curve; and (2) provide important insights into the impact, drivers and timing of the Covid-19 pandemic on developed market economies. The following four links provide examples of my analysis of MT investment perspectives:

Example chart 4: headling figures mask a more nuanced message from monthly flow data (Source: ECB; CMMP analysis)

Pillar 3: Short-term investment perspective

Example chart 5: banks played catch up from May 2020, but what kind of rally was this and was it sustainable? (Source: FT; CMMP analysis)

My ST investment perspective focuses on trends in the key macro building blocks that affect industry value drivers, company earnings and profitability at different stages within specific cycles. This perspective is influences by my experience of running proprietary equity investments within a fixed-income environment at JP Morgan. This led me to reappraise the impact of different drivers of equity market returns. I was able to demonstrate the “proof of concept” of this approach when I returned to the sell-side in 2017 as Global Head of Banks Equity Research at HSBC, most notably when challenging the consensus investor positioning towards European banks in 3Q17. A central ST theme is the importance of macro-building blocks in determining sector profitability and investment returns. The following four links provide examples of ST investment perspectives:

Example chart 6: why it was correct to question the conviction behind the SX7E rally during 2Q20 (Source: FT, CMMP analysis)

Pillar 4 – Financial Sector Balances

Example chart 7: Financial sector balances (and MMT!) can be understood easily by starting with the core services provided by banks to HHs and NFCs (Source: Bank of England; CMMP analysis)

In January 2020, I presented a consistent, “balance sheet framework” for understanding the relationship between the financial sector and the wider economy and applied it to the UK. I chose the UK deliberately to reflect the relatively large size of the UK financial system and the relatively volatile nature of its relationship with the economy. I extended this analysis to the euro area later. I began by focusing on the core services provided by the financial system (payments, credit and savings), how these services produce a stock of financial balance sheets that link different economic agents over time, and how these balance sheets form the foundation of a highly quantitative, objective and logical analytical framework. Central themes here were the large and persistent sector imbalances in the UK, why the HH sector in the UK was poised to disappoint and why a major policy review was required in the euro area even before the full impact of the COVID-19 pandemic was felt. The following four links provide examples of FSB analysis:

Example chart 8: Pre-Covid, the UK faced large and persistent sector imbalances and was increaingly reliant on the RoW as a net lender (4Q sum, % GDP) (Source: ONS; CMMP analysis)

Policy analysis

Example chart 9: “Fuelling the FIRE” – split in EA lending over past twenty years between productive (COCO) and less productive (FIRE) based lending (% total loans) (Source: ECB; CMMP analysis)

These four pillars provide a solid foundation for analysing macroeconomic policy options and choices. Since September 2019, I have applied them to identifying the hidden risks in QE, to arguing why the EA was trapped by its debt overhang and out-dated policy rules, and to assessing the policy responses to the COVID-19 pandemic. Central themes have included: (1) the hidden risk that QE is fuelling the growth in FIRE-based lending with negative implications for leverage, growth, stability and income inequality; (2) why the gradual and incomplete progress towards dealing with Europe’s debt overhang matters; (3) why Madame Lagarde was correct to argue that the appropriate and required response to the current growth shock “should be fiscal, first and foremost”; and (4) how three myths from the past posed a threat to the future of the European project. The following four links provide examples of policy analysis:

Example chart 10: failing the “common sense test”. What was the point of running tight fiscal policies when the private sector was running persistent financial surpluses > 3% GDP (Source: ECB; CMMP analysis)

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

“2Q20 message from the money sector – the UK”

Part 2 – a similar message to the euro area

The key chart

What uncertainty looks like – putting 2020 money holding trends into context
Source: Bank of England; CMMP analysis

The key message

The 2Q20 message from the UK money sector is very similar to the corresponding euro area version.

Headline data points suggest little change to the existing narrative. Households (HHs) and corporates (NFCs) continue to increase their money holdings, with rolling 3m inflows for the past four months since March exceeding the total inflows recorded for the whole of 2019. High levels of uncertainty still prevail. Above trend NFC borrowing and a recovery in HH mortgage demand offset the weakest YoY trends in consumer credit (-3.6% YoY) since 1994.

Again, analysis of monthly flows presents a more nuanced picture. Flows into sterling money holdings peaked back in March 2020, but remain more than double 2019 average monthly flows. The message for UK consumption is “less negative” – HHs repaid only £86m compared with a record £7bn in April. For context, this compares with average new monthly consumer borrowing of over £1bn per month in 2019. NFCs remain active borrowers from banks and financial markets, with June’s £11bn of borrowing driven mainly by capital market issuance. Bank lending to NFCs saw divergent trends. Large corporates repaid record amounts, but SMEs borrowed an additional £10bn. The annual growth rate in SME lending hit an all-time high, reflecting the impact of government support schemes.

In short, uncertainty in the UK has also peaked but remains very elevated, still.

Six charts that matter

HHs and NFCs continue to increase their sterling money holdings strongly
Source: Bank of England; CMMP analysis

In-line with developments in the euro area (EA), the headlines from the Bank of England’s money supply data for June 2020 also suggest little change to the on-going “message from the money sector” narrative.

The UK’s headline money series (M4ex) grew 11.9% YoY compared with the monthly average of 2.9% in 2019. HH money holdings (64% total) increased 7.5%, NFC money holdings (23% total) increased by 23.2% (YoY), and the volatile but smaller non-intermediating financing company (NIOFC) holdings (15% of total) increased by 17.7%.

The key chart above places these trends into context. Money holdings increased by £82bn in total during 2019, at an average of just under £7bn per month. The rolling 3m sums of money holdings for the past four months – March ($86bn), April (£113bn), May (£159bn) and June (£109bn) – all exceed the 2019 annual increase. This is what uncertainty looks like!

“Euro area trends on steroids” – above trend NFC credit and resilient HH mortgage demand offset weakness in HH consumer credit
Source: Bank of England; CMMP analysis

Looking at the counterparts to money holdings, again the story is similar to the EA version but with more exaggerated trends. NFC lending grew 9.2% YoY, down from 11.2% in May, but above trend. Mortgage demand grew 3.0% YoY, resilient but slightly below the 2019 average growth of 3.3%. However, HH consumer credit fell by -3.6% YoY, the weakest growth rate recorded since this series began in 1994. No real surprises here (at least in terms of trends).

Have uncertainty levels peaked, and if so, when? Monthly flows of sterling money holdings
Source: Bank of England; CMMP analysis

Continuing the parallels with the EA message, the monthly flow data presents a more nuanced picture than the headline data suggests. Monthly flows into sterling money holdings peaked at £67bn in March, almost 10x the 2019 monthly average flow. They fell back to £16bn in June, but this is still 2.3x the 2019 average monthly flow. The more volatile NIOFC flows peaked in March, but HH and NFC monthly flows did not peak until May (both at £26bn before falling to £12bn and £8bn in June respectively). Note that these large inflows are occurring despite negative real returns. The effective interest rates on new HH time (0.73%) and sight (0.26%) hit new lows having fallen 31bp and 20bp since February 2020 respectively. The effective interest rates on NFC time (0.17%) and sight (0.13%) also fell 10bp in June 2020.  

HH lending recovers in June after 2 months of large repayments
Source: Bank of England; CMMP analysis

After 2 months of large repayments (£7bn April, £3bn May), HH borrowing increased by almost £2bn in June. As can be seen from the chart above, the recovery in mortgage borrowing was the driver here. Looking ahead, mortgage approvals for house purchase also increased to 40,000 in June, up from the record low of 9,300 in May. However, June’s approvals were still well below February’s pre-Covid level of 73,700.  

HHs repaid only £86m of consumer credit in June compared with £4bn, £7bn and £5bn monthly repayments in March, April and May respectively. Positive, or less negative, news for the UK economy, but note that this small repayment contrasts with an average of £1.1bn in new consumer borrowing per month in the 18 months to February 2020 (Bank of England, June 2020).

Divergent trends in NFC borrowing – large corporates vs SMEs
Source: Bank of England; CMMP analysis

NFC lending saw divergent large NFC and SME trends. Large NFCs repaid a record £16.7bn in June, following a £13bn repayment in May. Approximately half of these repayments came from public administration and defence. The YoY growth rate for large NFC lending fell to 4.8% (dotted red line above) from 15.5% YoY in April. In “Credit where credit’s due“, I highlighted the important increase in SME borrowing in May (£18bn). In June, SMEs borrowed an additional £10bn well above the previous largest monthly SME borrowing of £0.6bn in September 2016. The YoY growth rate in SME lending hit a new high of 17.7% reflecting, in part, loans arranged through the government support schemes (eg, Bounce Back Loan Scheme).

June’s NFC financing driven by capital market issuance – bonds and equity
Source: Bank of England; CMMP analysis

NFCs borrowed almost £11bn from banks and financial markets in June. This was below the £32bn and £16bn borrowed in March and April respectively, but similar to May’s borrowing level. June’s borrowing was driven by capital market issuance – £7bn in bond issuance and almost £4bn raised in equity.

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

“Digitalisation coming ready or not”

Are UK building societies positioned to take advantage?

LT challenges – the key chart

UK households save too little and borrow too much
Source: ONS; ECB; CMMP analysis

The key message

The digitalisation of UK mortgage and savings is accelerating but structural and cyclical dynamics are challenging the strategies and profitability levels of building societies and compromising their ability to respond to the associated opportunities and challenges.

Summary of segmentation analysis

Building societies play an important role in UK financial services, helping their 25mn members to finance the purchase/building of their homes and to save.

The 43 societies currently account for 23% of outstanding UK mortgages (£337bn) and 18% of total HH savings (£297bn). The five largest account for c.90% of assets, members and industry profits. The balance sheet, members and annual profits of Nationwide, the UK’s largest building society, exceed the equivalent numbers for the rest of the industry combined.

CMMP analysis segments the industry by balance sheet, membership, infrastructure, P&L and geographic location and identifies four distinct tiers of building society.

It highlights how “the value” of members and branches and profitability drivers vary significantly across, and within, the four tiers and identifies those societies who enjoy neither the economies of scale of the Tier 1 societies nor the superior profitability (and income generation) of the smaller Tier 4 societies.

The Chairman of one society suggested recently, that many peers would be tempted to simply “trade through” the current crisis (supported by adequate capital) but that “they shouldn’t”. CMMP analysis not only supports this view but also provides a foundation for formulating the necessary strategic responses.

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

Key charts and slides

Five building societies dominate the market and Nationwide, the largest, has more assets, shares, members and generates more profits than the rest of the industry combined
Source: BSA, CMMP analysis
Challenges are reflected in divergent growth trends for assets and profits since 2015 (% CAGR)
Source: BSA; CMMP analysis
Even the more profitable societies are experiencing challenges to their profitability levels
Source: BSA; CMMP analysis
Larger building societies enjoy economies of scale (Tier 1 blue, Tier 2 red, Tier 3 green)
Source: BSA, CMMP analysis
Smaller building societies’ profitability levels reflect superior income generation (Tier 4 grey)
Source: BSA; CMMP analysis
Membership numbers and contribution vary across and within the four tiers
Source: BSA; CMMP analysis
Branch numbers and efficiency levels also vary across and within the four tiers
Source: BSA; CMMP analysis
How sacred are the industry’s sacred cows in a digitalised world?
Source: BSA; CMMP analysis

“Credit where credit’s due”

A positive SME message from the UK money sector

The key chart

Positive news from the money sector – SMEs able to borrow a record £18bn in May
Source: Bank of England; CMMP analysis

A snapshot on SME lending in the UK

In recent posts, I highlighted the widening financing gap between large corporates and SMEs in the UK and concerns that SMEs in the euro area were expecting the availability of external funding to deteriorate sharply.

“This time it’s different” – monthly change in SME loans since 2011 (£mn)
Source: Bank of England; CMMP analysis

This week’s “Money and Credit” release from the Bank of England brings some welcome, positive relief to this negative narrative. SMEs in the UK borrowed an extra £18bn from banks in May 2020. To put this into context, the previous largest increase in SME net borrowing was £589mn in September 2016. The Bank of England noted that this increase (11.8% YoY) “reflects businesses drawing down loans arranged through the government supported schemes such as the Bounce Back Loan Scheme”.

What a difference a month makes – YoY growth rates in NFC lending since May 2017
Source: Bank of England; CMMP analysis

These schemes helped reduce the effective interest rate on new loans to 0.98%, which is the lowest rate paid by SMEs since 2016 and compares very favourably with the 3.44% charged on new loans in February 2020.

The “effective” rate on new loans has fallen to a new low of 0.98%
Source: Bank of England; CMMP analysis

SMEs play a vital role in the UK economy. They account for 50% of total revenues generated by UK business and employ 44% of the UK’s workforce (McKinsey, June 2020). Up until this month, there were obvious concerns that limited access to funding and its relatively high cost were adding to the pressure of sharp revenue declines.

The large scale and lower cost of SME funding indicated in this week’s data release is a welcome, positive change in the message from the UK money sector.

Please note that these summary comments are extracts from more detailed analysis that is available separately

“Forced vs Precautionary”

May’s message from the UK money sector – risks from the HH sector

The key chart

The post COVID 19 outlook may be determined by the extent to which the dramatic increase in HH savings is forced or precautionary – financial sector balances provide important context here (£mn)
Source: Bank of England; CMMP analysis

Summary of CMMP analysis

Households (HHs) play a dominant role in the UK economy – their consumption accounts for 63p in every pound of GDP and their borrowing accounts for 76p in every pound lent.

In this context, heightened uncertainty, debt repayments and a marked increase in savings represent clear and rising risks to the economy and to bank sector profitability.

The £26bn record increase in HH deposits in May (6x the 10-year average monthly flow) reflects extreme uncertainty. HHs are repaying loans, notably consumer credit which has fallen -25% (annualised) over the past three months and -3% YoY (the weakest rate since 1994).

  • Pre-COVID 19, HHs funded consumption by dramatically reducing savings…
  • …during COVID 19, the savings ratio jumped sharply from an 11-year low of 5.2% in 3Q19 to 8.6% in 1Q20 (in-line with its LT average)…
  • …Post-COVID 19, the key question is the extent to which these savings are “forced” (constraints on spending during lockdown) or “precautionary” (response to actual or possible unemployment) in the UK and in the euro area.

Financial sector balances provide important historic context here given that the UK economy was characterised by large and persistent sector imbalances previously. Increasing deposits and/or reducing loan liabilities are likely to be part of a structural shift towards higher levels of HH net lending/financial surpluses.

Financial flows may remain volatile but a sharp reversal with savings moving rapidly back into either consumption or investment appears unlikely given the UK’s starting position.

Look instead for further fiscal stimulus (eg, a temporary cut in VAT).

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

Six key charts

The £26bn record increase in HH deposits in May reflects extreme uncertainty levels (£mn)
Source: Bank of England; CMMP analysis
HHs are actively repaying loans…(£bn on LHS, % YoY on RHS)
Source: Bank of England; CMMP analysis
…notably in consumer credit (credit cards and other consumer loans)
Source: Bank of England; CMMP analysis
Mixed messages from the mortgage market – HHs borrowed an additional £1bn in May after no growth in April (not shown here) but forward-looking approvals fell 66% on previous 6m average
Source: Bank of England; CMMP analysis
The HH savings ratio has jumped from an 11-year low of 5.2% in 3Q19 to 8.6% in 1Q20
Source: ONS; CMMP analysis
A structural shift to higher HH net financial surpluses would suggest that a rapid shift of savings back into consumption and investment is unlikely. Look for further, offsetting fiscal stimulus instead? (HH net financial surplus as % GDP)
Source: ONS; CMPP analysis

“Mind the financing gap”

Messages from the money sector IV – UK corporates

The key chart

The recovery in NFC credit demand is a positive sign but masks the widening volume gap between large corporate and SME funding (% YoY, £25m annual turnover threshold)
Source: Bank of England; CMMP analysis

Summary

UK corporate lending grew 11% in April 2020; the fastest rate of growth since July 2008 and in direct contrast to slowing trends in the household sector. April’s monthly change was lower than March’s “dash for cash” but was still double the monthly amounts borrowed over the previous six months. The cost of borrowing also fell to the lowest level since December 2010. NFCs are also increasing financing from bonds, commercial paper and, to a lesser extent, equities.

Behind these positive trends, the gap between large NFCs and SMEs is widening in volume terms. SMEs are benefitting from lower borrowing costs but volumes remain low and growth subdued. Furthermore, only 24p in every £ lent in the UK is directed to the NFC sector. More concerning, 77p in every pound is directed at less-productive FIRE-based lending (FIs and real estate).

The fact that NFCs are accessing finance in larger volumes and at lower costs is welcome, but the widening gap between large NFCs and SMEs and the on-going concentration of lending in less-productive sectors means that headline numbers are not as positive as they appear at first.

Mind the financing gap

In April, NFC lending grew at the fastest rate (11% YoY) since July 2008, in contrast to slowing growth (3% YoY) in the HH sector
Source: Bank of England; Haver; CMMP analysis

UK corporate (NFC) lending grew 10.7% YoY in April 2020, the fastest rate of growth since July 2008. This was in contrast to trends in the household (HH) sector, where credit growth slowed to only 2.5%, the slowest rate of growth since June 2015.

M4L in the NFC sector rose £8.4bn in April versus £4.3bn average over the previous six months
Source: Bank of England; CMMP analysis

Outstanding NFC loans grew by £8.4bn in April. This was lower than the £30.2bn raised in March but was still approximately double the average amounts borrowed over the previous six months (£4.3bn). The cost of (new) borrowing for NFCs fell to 2.26%, the lowest rate since December 2010 and 30bp lower than in February.

NFCs raised £32bn and £16bn from banks and financial markets in March and April 2020 respectively, versus an average of £3bn over the past three years
Source: Bank of England; CMMP analysis

Looking at wider financing trends, NFCs raised a total of £16.3bn from financial markets in April, down from the £31.6bn raised in March but still above the average monthly financing of £3.2bn seen over the past three years. After March’s “dash for cash” from banks, NFC repaid £1.0bn of bank loans in April but raised £7.7bn in bonds and £7.0bn in commercial paper (including finance raised through the Covid Corporate Financing Facility) and £1.4bn in equity.

After March’s “dash for cash” from banks, NFCs turned to the bond and commercial paper markets in April (£bn)
Source: Bank of England; CMMP analysis

These positive trends mask that (1) the gap between large corporates and SMEs is widening sharply in volume terms and, that (2) NFC lending remains a relatively small part of UK bank lending. SMEs are benefitting from lower borrowing costs: the effective rate on new loans to SMEs fell by 52bp to 2.49% in April the lowest level since 2016 (when the BoE series began) and almost 100bp below the 3.44% cost of borrowing in February. SMEs borrowed £0.3bn in April and March but this is only 1.2% higher than a year earlier.

SME credit growth is above recent average but remains subdued in absolute terms (% YoY)
Source: Bank of England, CMMP analysis

Despite the rise in NFC lending described above, only 24p in every £ of UK lending is lent to the NFC sector. Alternatively, using my preferred distinction between more productive “COCO-based” and less-productive “FIRE-based” lending, 77p in every pound lent in the UK is directed at financial institutions and real estate with obvious negative implications for leverage, growth, stability and income inequality.

Conclusion

The fact that UK corporates are accessing finance in larger volumes and at lower costs is welcome. Nonetheless, the widening gap between large corporate and SME financing is of concern as is the fact that UK lending remains concentrated in less-productive FIRE-based lending. This week’s Bank of England data contained good news for sure, but not to the extent that headline numbers might suggest.

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

“(Extreme) caution not consumption”

Messages from the money sector III – UK Households

The key chart

Risks to UK growth and bank lending from the HH sector rose sharply at the start of 2Q20 (% YoY)
Source: Bank of England; CMMP analysis

Summary

Risks to the UK growth outlook and bank lending from weakness in the household (HH) sector were evident before the Covid-19 pandemic hit. The “message from the money sector” (and from this week’s Bank of England monetary data) is that these risks rose at unprecedented rates at the start of 2Q20.

HHs increased deposit holdings in April 2020 by four-times the average monthly amount seen over the past two decades, despite negative real deposit rates. At the same time, they repaid debt in record amounts, notably consumer debt. Mortgage approvals also collapsed and mortgage lending grew at the lowest monthly rate since December 2011.

While it is dangerous to over-interpret one month’s data, the early message is clear:  with UK HHs displaying “extreme caution not consumption” and repaying debts despite low costs of borrowing, the on-going risks to a v-shaped recovery and to the UK banking sector profitability have risen sharply.

Caution not consumption

In “Poised to disappoint”, I highlighted the dominant role that HHs play in UK economic activity (FCE/GDP) and bank lending (the desire to buy properties). The HH sector had been funding recent consumption by dramatically reducing its savings rate and accumulation of net financial assets. With real growth in disposable income slowing and the savings rate close to historic lows, I concluded that the risks to UK growth lay to the downside even before Covid-19 hit.

Extreme caution – HH deposits rise at 4x the average monthly rate seen over the past twenty years (£mn)
Source: Bank of England; Haver; CMMP analysis

The current “message from the money sector” is that these risks have risen sharply and at an unprecedented rate. April’s monetary aggregates (released on 2 June 2020) showed that HHs increased their holdings of deposits by £16bn in April 2020, a rate that is 4x the size of the average monthly increase of the past twenty years and despite negative real rates of return.

Trends in UK HH deposit rates in nominal and real terms – rates remain negative in real terms but less so than in the recent past
Source: Bank of England; Haver; CMMP analysis

Interest rates on new time deposits fell 15bp to 0.98% while rates on sight deposits fell slightly to 0.41%. Deposit rates remain negative in real terms but less so than in the recent past due to the decline in inflation below 1.0%. The key message here is the HH sector’s rising preference for liquidity indicates very high levels of caution and a low appetite for risk.

HHs repaid twice as much consumer credit in April than in March (£bn LHS, % growth YoY RHS)
Source: Bank of England; CMMP analysis

At the same time, HHs are repaying debt in record amounts most notably consumer debt. They repaid £7.4bn of consumer debt in April 2020, twice the amount repaid in March. These repayments were the largest net repayments since the series began and unprecedented in scale (see graph below).

Current repayment levels are the largest since the series began and unprecendented in scale (£bn)
Source: Bank of England; Haver; CMMP analysis
Consumer credit now growing at the slowest rate since August 2012 (% YoY)
Source: Bank of England; Haver; CMMP analysis

The largest repayments (£5.0bn) were on credit cards, but HH also repaid £2.4bn of “other loans” (eg, car finance). In March and April, credit cards fell -0.3% and -7.8% YoY compared with 3.5% growth in February. Growth in other loans fell from 6.8% in February to 5.6% in March and 3.1% in April. While the slowdown in consumption is not surprising, its scale and pace send important signals regarding the hit to future consumption.

Within consumer credit, credit cards were hit hardest (% YoY)
Source: Bank of England; CMMP analysis

The money sector is also sending important messages about weakness in the housing market. Approvals for house purchase and remortgage have fallen 78% and 34% since February. Lending has also fallen rapidly. New mortgage borrowing fell 38% from £23.1bn in February to £14.1bn in April. At the same time, repayments also fell 26% from £18.8bn to £13.bn, reflecting (in part) the effect of payment holidays.

Trends in approvals (January – April 2020) show volumes collapsing in two months
Source: Bank of England; CMMP analysis

With gross lending falling faster than repayments, net mortgage borrowing rose by only £0.3bn in April compared with an average rise of £4.5bn over the previous six months. This net increase was the lowest since December 2011.

April’s net increase in mortgages (£0.3bn) was the slowest since December 2011
Source: Bank of England; CMMP analysis

Conclusion

It is dangerous to over-interpret one month’s data. Nevertheless, the early 2Q20 message from the money sector is clear:  with HHs displaying “extreme caution not consumption” and repaying debts despite low costs of borrowing, the on-going risks to a v-shaped recovery and to the UK banking sector profitability have risen sharply.

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

“Sustained fiscal loosening”

UK budget from a sector balances perspective

The key chart

“A major policy shift to sustained fiscal loosening” – current OBR forecasts for the UK budget (solid line) compared with March 2019 forecasts (dotted line) as % GDP
Source: OBR; CMMP analysis

A crucial week – part 1

On Wednesday 11 March 2020, the new UK Chancellor, Rishi Sunak announced the “largest sustained fiscal loosening since the pre-election Budget of March 1992” (OBR, 2020). Prior to the budget statement, the Bank of England also announced a package of measures – an unscheduled rate cut (to a historic low of 0.25%), the offer of cheap funding to banks, lowering banks’ capital buffers and expectations for banks to not increase dividends – in manner neatly described by the Chancellor as, “carefully designed to be complementary and to have maximum impact, consistent with our independent responsibilities.”

Government spending (% GDP) rising to late 1970s levels – a major shift
Source: OBR; CMMP analysis

Viewed through my preferred financial sector balances approach (summarised in Wynne Godley’s identity below), the new budget addresses last year’s (partially) flawed assumptions behind the policy of fiscal tightening ie, that a move towards a public sector surplus would be accompanied by a narrowing of the RoW’s net financial surplus and a widening of the private sector’s net financial deficit including higher level of borrowing. Instead it incorporates a widening in the net financial surplus of the household sector – appropriate given the high level of UK HH debt and low level of UK HH savings – offset by a widening in the public sector deficit. The assumptions regarding the balances of the NFC and RoW sectors remain largely unchanged.

Domestic private balance + domestic government balance + foreign balance = zero

Wynne Godley

On a positive note, this appears a more balanced policy including an appropriate shift in responsibility away from the HH sector to the UK government. The co-ordination between fiscal and monetary policy is also a positive sign. Nonetheless, the Government’s gross financing requirement averages around £150 billion a year over the next five years, around half as much again as a share of GDP as in the five years prior to the financial crisis. Hence, the OBR concludes that, “public finances are more vulnerable to adverse inflation and interest rate surprises than they were.” On top of this, the reliance on the RoW as a net lender to the UK economy remains an additional and obvious risk.

Attention now turns to the ECB. As noted in “Are we there yet?” the EA is positioned better to ease fiscal policy than the UK but immediate risks remain that policy response may be limited. Watch this space, we are half way though a crucial week for UK and European policy makers.

The charts that matter

Last year’s (partially flawed) assumptions
Last year’s partially flawed assumptions expressed within the sector balances framework (% GDP)
Source: OBR; CMMP analysis

“We expect the public sector deficit to narrow slightly, offset by a small narrowing in the rest of the world surplus. The corporate and household sector deficits are expected to remain broadly stable. The general profile of sector net lending is little changed from previous forecasts, although the size of the household sector deficit is slightly smaller than in our October forecast, consistent with an upward revision to our forecast for household saving. The size of the rest of the world surplus is slightly larger, reflecting the upward revision to our forecast of the current account deficit.” (OBR, 2019)

New versus old – the HH sector
HH sector is now expected to run wider net financial surpluses of between 1.3% and 1.6% of GDP
Source: OBR; CMMP analysis
New versus old – the public sector (and the policy shift)
The end of austerity and a shift to sustained fiscal loosening (public sector net financial deficit as % GDP)
Souce: OBR; CMMP analysis
New versus old – little change to NFC sector forecasts
NFC deficits are forecast to offset HH surpluses meaning that the private sector remains in deficit in aggregate (% GDP)
Source: OBR; CMMP analysis
New versus old – still reliant on the RoW as a net lender
“Still very dependent” – the OBR assumes that the RoW will continue to run net financial surpluses of c.4% GDP over the forecast period (% GDP)
Source: OBR, CMMP analysis
March 2020 forecasts expressed through sector balances
Widening HH surpluses offset by looser fiscal policy and widening NFC deficits (% GDP)
Source: OBR; CMMP analysis

Conclusion

We are half way through a crucial week for UK and European policy makers. The first half saw a sustained loosening of fiscal policy by the new UK Chancellor, co-ordinated neatly with a package of measures from the Bank of England. This leaves a more balanced and appropriate policy mix.

In the second half, attention now focuses on the ECB and EA governments. The euro area is better placed than the UK to relax fiscal policy but the immediate risk remains that the policy response may be more limited. Watch this space.

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

chris@cmmacroperspectives.com

“Imbalances and dependencies”

Spotlight on the UK 5 – implications for growth and policy

The key chart

The UK faces large and persistent sector imbalances and is increasingly reliant on the ROW as a net lender (4Q sum, % GDP)
Source: ONS; Haver; CMMP analysis

Introduction

I began this series of five posts by stating that:

“the true value in analysing developments in the financial sector lies less in considering investments in developed market banks – they have been lousy LT investments – but more in understanding the implications of the relationship between the banking sector and the wider economy for corporate strategy, investment decisions and asset allocation.”

Lousy LT investments – UK, US and EU banks have signficantly underperformed local markets (relative performance 2004-2019)
Source: Haver; CMMP analysis

Over the next three posts, I presented a consistent, “balance sheet framework” for understanding this relationship and applied it to the UK economy and the three core sectors within the private sector – Financial Institutions (FIs), Households (HHs) and Non-Financial Corporations (NFCs).

I chose the UK economy deliberately to reflect the relatively large size of the UK financial system, and the relatively volatile nature of its relationship with the economy. Of course, the framework is applicable to any economy and my conclusion here will make reference to similar analysis for the euro area, and Germany specifically. More analysis of sector balances in Europe will follow soon.

The UK faces large and persistent sector imbalances and is increasingly reliant on the “rest of the world” (ROW) as a net lender.

At the end of 3Q19, the UK private and public sectors were running net financial deficits of -3.4% and -2.0% GDP respectively. These were offset by the ROW’s net financial surplus of 5.4%.

The key (OBR) assumptions behind the policy of fiscal tightening were that a move towards a public sector surplus would be accompanied by a narrowing of the ROWs net financial surplus and a widening of the private sector net financial deficit including high levels of borrowing. The first assumption proved wrong and the second only partially correct.

The 2020 OBR forecasts published in March will shed light on the government’s current assumptions but in the meantime I see downside risks to consumption and UK GDP growth and to further fiscal consolidation.

UK spotlights 1-4 in review

“Lousy LT investments, but…”

Contrasting trends between the relative sizes of the real and money sectors’ financial assets in the UK and euro area (multiple of GDP)
Source: ONS; ECB; Haver; CMMP analysis

In “Lousy LT investments, but…” I presented a mapping exercise for the UK economy and its financial system. The key message was that a distinguishing feature of the UK economy was the relatively large size (and hence potential impact) of the money sector and the volatile nature of its relationship with the wider economy.

“Everyone has one…”

I started with examples of three (of the four) core services provided by the financial system to HHs and NFCs
Source: adapted from “Mapping the UK financial system”, Bank of England Quarterly Bulletin 2015 Q2 article

In “Everyone has one…”, I focused on the core services provided by the UK financial system (payments, credit and savings), how these services produce a stock of contracts that can be represented by financial balance sheets that link different economic agents over time, and how these balance sheets form the foundation of a highly quantitative, objective and logical analytical framework. This post built up to the key identity pioneered by the late Wynne Godley that states that:

Domestic private balance + domestic government balance + foreign balance = zero.

“Poised to disappoint”

Over the past thirty years, there have been two (post-crises) phases when UK HHs have reduced their net financial savings dramatically (4Q sums, % GDP)
Source: ONS; Haver; CMMP analysis
Both phases have been associated with declines in the absolute level of savings (£ millions, LH scale) and in the savings rate (%, RH scale)…
Source: ONS; Haver; CMMP analysis
… but only the first one was also associated with a signficant rise in HH leverage (HH debt as % GDP)
Source: ONS; Haver; CMMP analysis

In “Poised to disappoint…”, I highlighted the dominant role that UK households play in economic activity (FCE/GDP) and bank lending (the desire to buy properties) and their important role as investors in financial and non-financial assets. The key message was that while the HH was typically a net saver, the sector has been funding recent consumption by dramatically reducing its savings rate and accumulation of net financial assets (but not by increasing debt ratios). With real growth in disposable income slowing and the savings rate close to historic lows, I suggested that risks to UK growth lay to the downside and at odds with (past) government forecasts.

“Alternative investments”

UK NFCs are typically net borrowers in financial markets ie, investment vehicles for other sectors in the balance sheet framework (4Q sum, % GDP)
Source: ONS; Haver; CMMP analysis

In “Alternative investments”, I described the key economic roles of the NFC sector and explained that its (typical) requirement to borrow in financial markets in order to invest in non-financial assets meant that NFCs represent an important alternative investment vehicle for other sectors – offering stakes in their earnings (dividends) or interest payments in their debt. I concluded by asking that if NFCs widened their deficits further in order to fund investment, which sector will be increasing its surplus as an offset?

Imbalances and dependencies

The key chart repeated – The UK faces large and persistent sector imbalances and is increasingly reliant on the ROW as a net lender (4Q sum, % GDP)
Source: ONS; Haver; CMMP analysis

Roles and balance sheets revisited

To re-cap, FIs, HHs and NFCs – the three core “economic groups” comprising the UK private sector – have distinct economic roles. In fulfilling these roles, they produce a stock of contracts that can be represented by financial balance sheets. These balance sheets link each group together (directly and indirectly) and form a highly quantitative, objective and logical analytical framework. A fundamental principle of accounting is that for every financial asset there is an equal and offsetting financial liability. In other words, if we take all of the financial assets and financial liabilities it is a matter of logic that the sum of the financial assets must equal the sum of the financial liabilities.

Financial sector balance sheets by sector as at end 3Q19 (£ billions)
Source: ONS; Haver; CMMP analysis

An important implication of this analysis is that for the private sector to accumulate net financial wealth (financial assets minus financial liabilities) it must be in the form of claims on another sector. In the simplified case of a two sector economy, the net financial assets held by the private sector are exactly equal to the net financial liabilities of the government. In this case, it is impossible for the private and public sectors to run surpluses at the same time.

In a simplified, two-sector economy this would not be possible. The UK private and public sectors are running net financial deficits at the same time. (4Q sums, % GDP)
Source: ONS; Haver; CMMP analysis

Of course, in reality these domestic sectors are also linked economically to foreign FIs, NFCs, HHs and governments, collectively termed the “rest of the world” (ROW). Hence, the private sector can accumulate net financial assets equal to public sector liabilities, the ROW’s net liabilities or a combination of the two.

The private, public and ROW sectors can be treated as having income and savings flows over a given period. If a sector spends less than it earns it creates a budget surplus. Conversely, if it spends more that it earns it creates a budget deficit. A surplus represents a flow of savings that leads to an accumulation of financial assets while a deficit reduces net wealth. If a sector is running a deficit it must either reduce it stock of financial assets or it must issue more IOUs to offset the deficit. If the sector runs out of accumulated financial assets, it has no choice other than to increase its indebtedness over the period it is running the deficit. In contrast a sector that runs a budget deficit will be accumulating net financial assets. This surplus will take the form of financial claims on at least one other sector.

Implications for growth and policy

Large and persistent imbalances – net financial balances for the UK private and public (G0v) sectors and the ROW (4Q sums, % GDP, averages and snapshots)
Source: ONS; Haver; CMMP analysis

Applying this framework to the UK economy, I see large and persistent sector imbalances. Prior to the global financial crisis (GFC), the UK government ran an average net financial deficit of 2.5% GDP between September 1989 and September 2008. Of course, in the aftermath of the GFC, the private sector moved sharply into net financial surplus as one would expect. More surprisingly, given movements in real effective exchange rates, the ROW net financial surplus also remained high. The offset over this period was the widening of the government deficit to 10.4% which was an appropriate and necessary response to prevent a much deeper recession. Since December 2009, the average government net financial deficit has been 5.5% (ie more than double the pre-crisis average). This has been offset by private sector and RoW surpluses of 1.3% and 4.2% respectively.

The UK is becoming increasingly reliant on the ROW as a net lender. The trend in the ROW net financial balance since 1989 (4Q sum, % GDP)
Source: ONS; Haver; CMMP analysis

I also see an increasing reliance on the RoW as a net lender to the UK economy. The key (OBR) assumptions behind the policy of fiscal tightening after the GFC were that the move towards a public sector financial surplus would be accompanied by a reduction in the ROWs net financial surpluses and a widening of the private sector’s net financial deficit driven by higher borrowing. The first assumption proved wrong and the second assumption on partly correct.

As at the end of 3Q19, the ROWs net financial surplus was 5.4% of GDP. This was offset by a narrow government deficit of 2.0% GDP and a wider private sector deficit of 3.4% GDP. Both the private and public sectors in the UK are running net financial deficits at the same time, something that can only happen is the ROW is running a compensating net financial surplus.

No borrowing boom. Trends in NFC and HH debt ratios (% GDP)
Source: BIS; ONS; Haver; CMMP analysis

NFCs (and FIs) have increased their debt ratios slightly since 2015, but the HH sector debt ratio has remained stable. As discussed in “Poised to disappoint”, the HH sector has been funding consumption by slowing its rate of savings (sharply) and accumulation of net financial assets.

Its important, so worth repeating – UK HHs have reduced their absolute levels of savings (£ millions, LH scale) and their savings rate (%, RH scale)
Source: ONS; Haver; CMMP analysis

From this, I see risks to consumption and UK GDP and to further fiscal consolidation. High absolute levels of HH debt (% GDP) are constraining HH borrowing. Trends in disposable income and savings are, therefore, likely to be key factors driving HH consumption and growth in the UK. With real growth in disposable income disappointing and savings rates close to historic lows, the risks to UK growth from this analysis appear tilted to the downside.

Previous assumptions behind the policy of fiscal consolidation have already been revised to reflect the persistence of large RoW net financial surpluses. However, even the 2015 OBR forecasts that still assumed a narrowing of this surplus, required ambitious assumptions regarding the propensity of the private sector to increase their borrowing and financial deficits.

With larger than forecast ROW net financial surpluses, further fiscal consolidation requires even more private sector borrowing which I see as unlikely. The 2020 OBR forecasts published in March will shed light on the government’s forecasts but in the meantime, I see further risks to their previous assumptions.

What next? Europe…

In future posts, I will be analysing euro area economies through the same balance sheet framework. Dependency on the ROW is also relevant, but for very different reasons. In direct contrast to the UK trends described above, the German private and public sectors are both running net financial surpluses. These are offset by ROW net financial deficits.

Mirror, mirror – Germany is dependent of ROW remaining net borrowers (4Q sums, % GDP)
Source: ECB; Haver; CMMP analysis

The UK is dependent on ROW remaining net lenders, Germany is dependent on the ROW remaining net borrowers.

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