“Look beyond the yield curve II”

Messages from the money sector

Earlier this month, I argued that (1) leading indicators were giving mixed messages about recession risks in the Euro Area; (2) that monetary indicators were comfortably above the levels the ECB associate with risks of recession; but (3) that the ECB was still expected to cut rates and to restart QE.

No surprises since then from the ECB. However, monetary indicators have moved even further away from levels associated with recession risks. Growth in real M1 (a leading indicator) accelerated in August, and real growth in household credit (a coincident indicator) and corporate credit (a lagging indicator) are at the highest levels in the current credit cycle. The message from the money sector in August is that current trends remain inconsistent with recession risks in the Euro Area.

No surprises from the ECB in September

The Deposit Facility Rate was cut from minus 0.4% to 0.5% in-line with expectations at this month’s meeting. The ECB also announced that it would restart buying €20bn of bonds per month until inflation hits its target of 2%. It also introduced a new “tiered” system of interest rates to reduce the cost to banks from negative rates (as discussed in “Power to the Borrowers”). No surprises here.

What are monetary developments telling us?

To recap, growth rates in real M1 and lending to the private sector demonstrate robust relationships with the business cycle through time. Real M1 tends to lead fluctuations in real GDP with an average lead time of four quarters. Real household (HH) credit growth tends to lead slightly (one quarter) or have a coincident relationship with real GDP. In contrast, real corporate (NFC) credit tends to lag fluctuations in real GDP with a lag of three quarters.

Monetary indicators moved even further away from levels associated with recessions risks in August. Real M1, an alternative leading indicator with a stronger and more stable relationship with real GDP than the slope of the yield curve, grew 7.3% in August compared with 6.7% in July and 4.7% in January this year. This is the fastest rate of real growth in narrow money since January 2018.

Real HH credit (a leading/co-incident indicator) and Real NFC credit (a lagging indicator) grew at 2.4% and 3.3% respectively. In both cases, this was the fastest rate of growth in the current credit cycle. France (1.3%), Germany (1.2%), Benelux (0.3%) and Italy (0.2%) were the main contributors to HH credit growth (contributions here are in nominal terms).

In the NFC sector, France (1.8%) and Germany (1.5%) were again the main country drivers, but Italy (-0.6%) and Spain (-0.2%) both made negative contributions to nominal Euro Area growth rates.

The message from the money sector in August is that current trends remain inconsistent with recession risks in the Euro Area. The domestic sectors are demonstrating resilience in contrast to the contraction seen in the more export-oriented manufacturing sectors. The latest trends remain supportive of current ECB and EC forecasts which point to a shallow recovery in growth in 2H19.

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