“Cold water therapy or cold shower?”

The key chart

The key message

Monetary developments in the euro area (EA) present atypical foundations for a bull market in European equities.

The good news is that EA households have stopped hoarding cash and the region’s money and credit cycles have resynched with each other. Two (of three) key signals from the money sector suggesting a normalisation of economic activity.

The bad news is that the money and credit cycles are rolling over, credit demand is slowing in nominal terms, and growth rates in M1, HH credit and NFC credit are negative in real terms. This matters because these three variables (real M1, HH credit and NFC credit) typically display leading, co-incident and lagging relationships with real GDP over time. If historic relationships continue, this suggests a deceleration rather than an acceleration in economic activity over the next quarters.

The key question for asset allocators, therefore, is – do current monetary trends represent a form of positive, cold water therapy or simply a less-attractive cold shower?

Cold water therapy or cold shower?

Monetary developments in the EA present atypical foundations for a bull market in European equities. Growth in broad money (M3) fell to 4.1% in December 2022, down from 4.8% in November 2022. This represents the slowest rate of growth since January 2019 (see chart above). Growth in narrow money (M1) slowed sharply to 0.6% in December 2022, down from 2.4% in November 2022. This represents the slowest rate of growth since August 2008. At the same time, the SXXE index closed at 449.17 on Friday 27 January 2023, up 26% from its early 4Q22 low.

The good news from the money sector is that EA households have stopped hoarding cash and the region’s money and credit cycles have resynched with each other. Recall that cash hoarding by HHs and NFCs in the form of overnight deposits was the key driver of the rapid expansion in broad money during the pandemic – a combination of forced and precautionary savings (see light blue columns in the chart above).

In the 4Q22, the flow of HH deposits fell to €26bn, the lowest quarterly flow since the pandemic began and well below the 2Q20 peak of €190bn and the pre-pandemic average flow of €91bn (see chart above). Recall also that a moderation in HH deposit flows was one of our three key signals for a normalisation of economic activity post-COVID. A second was a re-synching of money and credit cycles (see below).

Money and credit cycles have been desynchronised for much of the past decade, creating major challenges for policy makers, banks and investors alike. The gap between the growth in money supply and the growth in private sector credit (PSC) hit a historic high during the COVID-pandemic (see chart above). As the region emerged from the pandemic, these growth rates have converged as the build-up in excess savings has slowed and the demand for credit has recovered (at least in nominal terms). A positive sign.

The bad news is that the money and credit cycles are rolling over, credit demand is slowing in nominal terms, and growth rates in M1, HH credit and NFC credit are negative in real terms. Growth in adjusted PSC, for example, slowed to 5.3% in December 2022, down from 6.2% in November 2022 and down from the recent September 2022 peak of 7.0% (see chart above).

The monthly flow of mortgages, for example, fell to €4.5bn in December 2022, down from €8.9bn in November 2022 and down from the recent peak of €30.1bn in June 2022. The latest monthly flow was the lowest recorded since March 2020 (see chart above). The YoY growth rate in mortgages also fell to 4.4% in December 2020 down from 5.8% YoY in August 2021.

Monthly consumer credit flows also remain subdued in absolute terms and in relation to trends seen in the US and the UK. The monthly flow fell to €0.5bn in December 2022 from €2.1bn in November 2022 and €2.4bn in October 2022. As noted in “Clues from consumer credit”, the risks to EA economic growth lie more in the lack of demand for consumer credit and on-going household uncertainty.

Real growth rates in M1, HH credit and NFC credit typically display leading, coincident and lagging relationships with real GDP over time. Each indicator has peaked and is falling in real terms – -7.9% YoY, -4.9% YoY and -2.7% YoY respectively in December 2022 (see chart above). If historic relationships between these variables continue, this suggests a deceleration rather than an acceleration in economic activity over the next quarters.

In short, the key question for asset allocators is – do current monetary trends represent a form of positive, cold water therapy or simply a less-attractive cold shower?

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