“Completing the transition”

The key chart

The key message

Monetary developments in the euro area (EA) indicate a clear transition away from “pandemic-era” economics.

Growth rates in broad money (M3) recovered during 3Q22 but remained well below pandemic levels. Three important, positive developments lay behind the headline growth figures.

• First, the period of heightened uncertainty and subdued demand for credit that reached a peak during the pandemic has ended.
• Second, and following on from this, EA money and credit cycles are re-synching with each other as the demand from credit recovers to levels last seen in December 2008.
• Third, and perhaps most importantly, the breakdown of private sector credit is shifting back towards increased demand for productive (COCO-based) lending – corporate credit is accelerating while mortgage demand is moderating slowly.

So far, so good.

Rising inflation is outweighing each of these positive developments, unfortunately.

Monetary trends adjusted from inflation, are sending very different and consistently negative messages. Real growth rates in M1, HH credit and NFC credit typically display leading, coincident and lagging relationships with real GDP. Each indicator is falling at an increasing rate.

If historic relationships between these variables continue, this suggests a deceleration in overall economic activity over the next quarters.

Completing the transition

Monetary developments in the euro area (EA) indicate a clear transition away from “pandemic-era” economics.

Growth rates in broad money (M3) recovered during 3Q22 but remained well below pandemic levels. M3 rose 6.3% YoY in September, up from 6.1% YoY in August and 5.7% YoY in July. Despite this, broad money growth was 6.2ppt below its 12.5% YoY January 2021 peak (see chart above).

Narrow money (M1), a key component of broad money, rose only 5.6% YoY, however, down from 6.8% YoY in both August and July. Narrow money growth was 10.9ppt below its 16.5% YoY January 2021 peak.

Behind the headline YoY growth figures lie three important, positive developments.

First, the period of heightened uncertainty and subdued demand for credit that reached a peak during the pandemic has ended. Recall that the hoarding of cash by HHs and NFCs, largely in the form of overnight deposits at banks, was the main driver of the spike in broad money during the pandemic (see graph above). M3 growth peaked at 12.5% YoY in January 2021. At the same time, M1 and overnight deposits grew 16.5% YoY and 17.1% YoY and contributed 11.3ppt and 10.1ppt to total broad money growth respectively.

With heightened levels of uncertainty, HHs were increasing their forced and precautionary savings. The key point here is that money sitting idly in overnight deposits at banks contributed to neither economic growth nor inflation.

Note also, that at the point of maximum M3 growth, private sector credit grew only 4.5% YoY and contributed only 5.4ppt to the 12.5% YoY growth in broad money (see graph above).

Fast forward to September 2022, and private sector credit grew 6.9% YoY in September, up from 6.8% YoY in August and 6.3% YoY in July. At the end of 3Q22, private sector credit contributed 5.4ppt to the total 6.3% YoY growth rate in broad money. This represents a clear break from the monetary dynamics seen during the pandemic (see key chart above).

Second, and following on from this, EA money and credit cycles are re-synching with each other as the demand from credit recovers to levels last seen in December 2008.

As noted in “Don’t confuse the messages”, monetary aggregates and their counterparts move together in typical cycles. 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.

The “pandemic-era” relationship between money and credit cycles was far from typical, however. In January 2021, the gap between the YoY growth rate in M3 (12.5% YoY) and private sector credit (4.5% YoY) reached a historic high of 8ppt (see chart above).

During 2021, CMMP analysis focused on this dynamic as one of the three key signals to monitor. In September 2022, private sector credit grew faster (6.9% YoY) than money supply (6.3% YoY) for the fourth consecutive month as money and credit cycles re-synched with each other.

Third, and perhaps most importantly, the breakdown of private sector credit is shifting back towards increased demand for productive (COCO-based) lending – corporate credit is accelerating while mortgage demand is moderating slowly.

Recall that the outstanding stock of loans that support production and income formation in the euro area (COCO-based loans) only recovered to the GFC period peaks in November 2021 (see chart above). Nearly all of the aggregate growth in euro area lending since the GFC has been in the form of less-productive FIRE-based lending (see “Fuelling the FIRE” and “It’s a record of sorts”).

In September 2022, COCO-based and FIRE-based lending both contributed 3.3ppt to the total 6.6% YoY growth in (unadjusted) private sector credit (see graph above). This contrast sharply with the situation a year earlier in September 2021 when COCO-based and FIRE-based lending contributed 0.7ppt and 2.5ppt to the total 3.2% YoY growth rate.

Significantly, the growth rate in lending to NFCs (the largest element of COCO-based lending) grew faster (8.0% YoY) and contributed more to total lending (3.1ppt) than mortgage lending (the largest element of FIRE-based lending) which grew 5.1% YoY and contributed 2.1ppt to total lending.

So far, so good.

Rising inflation is outweighing each of these positive developments, unfortunately. Monetary trends adjusted from inflation, are sending very different and consistently negative messages.

Real growth rates in M1, HH credit and NFC credit typically display leading, coincident and lagging relationships with real GDP. Each indicator is falling at an increasing rate (see chart above). If historic relationships between the variables continue, this suggests a deceleration in overall economic activity over the next quarters.

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