“Is the Coco cooling?”

The key chart

The key message

The positive private sector credit (PSC) dynamics that supported a more optimistic outlook for euro area (EA) economic activity proved unsustainable in 4Q22.

The context for this week’s ECB policy announcement remains a challenging one with coincident and lagging monetary indicators slowing sharply.

The “Coco is cooling” at the start of the new year…

Is the Coco cooling?

PSC dynamics supported a more optimistic outlook for EA economic activity through 2022. PSC growth accelerated and productive COCO-based lending made an increasing contribution to this growth (see key chart above). A recovery in corporate (NFC) credit demand led this process. Both factors were positive for the EA growth outlook. Unfortunately, neither proved sustainable in 4Q22.

PSC growth peaked at 6.7% YoY in September. At this point COCO-based and less-productive, FIRE-based lending both contributed 3.3ppt to total PSC growth. By the end of 4Q22, PSC growth had slowed to 5.0% YoY, with the COCO-based and FIRE-based lending contributing 2.4ppt and 2.7ppt respectively. The key driver here was the peaking of NFC credit, the largest segment of COCO-based lending. NFC credit growth has slowed from 8.1% in October 2022 to 5.5% in December 2022.

Recall that unorthodox monetary policy (QE) had fuelled the wrong type of lending in the EA. At the time of the GFC, the outstanding stock of COCO-based lending peaked at €5,517bn in January 2009, and contributed 55% of total PSC. This level was not reached again until December 2021. At this point COCO-based lending contributed only 48% of total PSC. In other words, nearly all of the aggregate growth in EA lending between these dates was in the form of lending to support capital gains through rising asset prices (see chart above). This explains why last year’s dynamics were so important – demand for productive lending was recovering again.

Unfortunately, annual growth rates in mortgages (the largest contributor to FIRE-based lending) and NFC credit (the largest contributor to COCO-based lending) fell -4.9% YoY and -2.7% YoY respectively in December 2022 (see chart below).

As noted in my previous post, these variables typically display coincident and lagging relationships with real GDP growth. Both are suggesting rising risks to the economic outlook in the euro area. This is the context for the latest policy announcement from the ECB on Thursday.  

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