The key chart
The key message
Current money cycles in the EA and UK, (1) differ from previous cycles in terms of their drivers and implications, (2) are out-of-synch with the respective credit cycles, and (3) diverging from credit cycles at historically rapid rates. The implications here for growth, inflation, policy choices, investment returns and asset allocation are missing from many recent “2021 Investment Outlooks”.
Is it wise to ignore the “messages from the money sector”?
This week’s data releases show broad money growing at the fastest rate in the current money cycle in both the EA (11.0%) and the UK (13.9%). What is this telling us?
Households are increasing their money holdings at 2-4x the average 2019 monthly rate, delaying consumption and repaying existing consumer credit with negative implications for economic growth and inflation.
In terms of policy choices, monetary policy effectiveness requires stable relationships between monetary aggregates, but these are increasingly absent. The gap between growth rates in money supply and private sector credit demand is at record highs in both regions – one more reason to add to the list of why the required policy response is, “fiscal, first and foremost.”
For some, rising money supply suggests higher inflation in the EA and the UK and supports asset allocation shifts towards cyclical and value plays and shorter duration trades. The message from the money sector with elevated uncertainty, low confidence, weak consumption and subdued credit demand is, “not so fast.”
The charts that matter
This week’s ECB and Bank of England data releases show broad money growing at the fastest rate in the current money cycle in both the EA and the UK (see chart above). M3 in the EA grew 11.0% YoY in November 2020, up from 10.5% in October. M4ex in the UK grew 13.9% YoY in November 2020, up from 13.2%.
To understand what these trends are telling us, and to understand how the current money cycle differs from previous cycles, we need to examine both the components and counterparts to broad money rather than focus simply on the headline numbers.
From a components perspective, we can see that growth in narrow money i.e. notes and coins in circulation and, more importantly, overnight deposits is the key driver of overall money growth (see chart above). In the EA, for example, M1 grew at 14.5% YoY and contributed 9.9ppt to the 11.0% YoY growth in M3. Overnight deposits grew 15.0% YoY and contributed 8.9ppt to the total growth alone.
Recent trends are an extension/acceleration of longer-term secular shifts in the composition of EA and UK money supply (see chart above). Twenty years ago, M1 accounted for 42% and 48% of M3 in the EA and UK respectively. The shares were the same at the height of the GFC in 2008. Today, however, M1 accounts for 71% and 68% of M3 in the EA and the UK respectively. This increase in liquidity preference/money holdings reflects an increasingly lower opportunity cost of holding money as rates have fallen and, more recently, a sharp rise in both forced and precautionary savings by the regions’ households.
Households are increasing their money holdings at 2-4x the average 2019 monthly rate, delaying consumption and repaying existing consumer credit with negative implications for economic growth and inflation. In the EA, household money holdings increased by EUR61bn in November, almost double the average flow of EUR33bn recorded during 2019 (see chart above). This reflects similar, albeit more volatile, trends in the UK highlighted in, “And now, the not-so-good-news” and to repeat the message in that post – money sitting in savings accounts does not contribute to GDP or higher inflation.
EA households are not only delaying consumption, they are also repaying existing consumer credit. In November 2020, net repayments totalled EUR4bn, the largest amount since the peak of the first wave of the pandemic in April. On a YoY basis, consumer credit declined by 1.1%, the weakest level in the current slowdown (see chart above). In the UK, households repaid consumer credit for three consecutive months between September and November 2020 and YoY declines are the weakest since records began.
In terms of policy choices, monetary policy effectiveness requires stable relationships between monetary aggregates, but these are increasingly absent. The gap between growth rates in money supply and private sector credit demand is at record highs in both regions. In the EA, the gap between the supply of money (11.0%) and private sector demand for credit (4.7%) was 6.3ppt. In the UK, money supply grew 13.9%, 9.4ppt faster than private sector credit demand. This is one more reason to add to a lengthening list of why the required and sustained policy response should be, “fiscal, first and foremost.” In my next post, I will up-date my analysis to add another factor to this list i.e. credit is increasingly shifting towards less productive sectors of the economy (see also “Fuelling the FIRE – the hidden risk in QE“).
Conclusion
For some, rising money supply suggest higher inflation in the EA and the UK, and supports asset allocation shifts towards cyclical and value plays and shorter duration trades. The message from the money sector remains, “not so fast.”
CMMP analysis of the components and counterparts of broad money tell a very different story from previous money cycles. The EA and UK money sectors are consistent signalling elevated uncertainty, low confidence, weak consumption and subdued credit demand – even before the introduction of further, more stringent lock-down policies in January 2021.
If there is a positive interpretation of current trends, it is that there is a large element of forced savings and hence pent-up consumer demand. That is true, but history also tells us that households and corporates can take time to adjust to major economic shocks and caution us against expecting a rapid reversal in confidence and consumption.
Please note that the summary comments above are extracts from more detailed analysis that is available separately