The key chart
Trends in financing flows (EUR bn) and nominal policy rates (%) (Source: ECB; CMMP)
The key message
The unprecedented speed of monetary policy transmission to the cost of borrowing for EA corporates and households and the subsequent collapse of private sector financing flows complicate policy options for the ECB going forward and raise the risks of policy errors considerably.
The combination of negative financing flows and policy rates that are at a historic high in nominal terms and the highest level since September 2007 in real terms is unlikely to be sustainable. This is before the pass through to the cost of borrowing for corporates and households is fully completed and taken into account.
Unfortunately, the ECB lacks a playbook for its unprecedented policy moves and their equally unprecedented consequences. EA economies also find themselves in uncharted territory. The risks of policy errors continue to mount.
Disappearing private sector financing flows – Part II
Cumulative 12-month financing flows to the EA private sector peaked at €811bn in September 2022, three months after the ECB began tightening policy rates. They turned negative in September 2023 (-€37bn) and remained negative in October 2023 too (-€5bn).
Unusually, negative financing flows coincide currently with policy rates that are high in both nominal and real terms. Current policy rates are at their highest nominal level (4.50%) since the introduction of the euro in 1999 (see key chart above). In real terms, the main policy rate is also at its highest level (1.55%) since September 2007 – albeit below April 2007’s peak real rate of 2.26% (see chart below).
Trends in financing flows (EUR bn) and real policy rates (%) (Source: ECB; CMMP)
The release of October 2023’s composite costs of borrowing for EA corporates and households is scheduled for 4 December 2023. Assuming no change from September (an unlikely assumption), the real cost of borrowing for corporates and households is relatively restrictive levels of 2.1% and 1.0% respectively already (due to the fall in inflation). This is before the full pass through to the cost of borrowing for corporates and households is taken into account (see chart below).
Trends in financing flows (EUR bn) and real NFC and HH borrowing costs (%) (Source: ECB; CMMP)
Conclusion
In short, the combination of negative financing flows and policy rates that are at a historic high in nominal terms and the highest level since September 2007 in real terms is unlikely to be sustainable.
Unfortunately, the ECB lacks a playbook for its unprecedented policy moves and their equally unprecedented consequences. EA economies also find themselves in uncharted territory. The risks of policy errors continue to mount.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.