“Still tightening as stresses mount”

The key chart

The key message

As growth in euro area (EA) money supply in February 2023 falls to its slowest rate (2.9% YoY) since October 2014, the “message from the money sector” includes three key warning signs for the ECB and for investors in the region:

• Warning sign #1: banks’ top-line growth. Banks continue to experience net outflows of ST liabilities and a substitution away from low-cost overnight deposits to more expensive “other ST deposits”, at the margin (this is not just a US story). At the same time, credit growth is slowing i.e. negative price and volume effects.
• Warning sign #2: house prices and household consumption. Monthly flows of mortgage and consumer credit have slowed sharply, to well-below pre-pandemic levels.
• Warning sign #3 (re-enforced): weakening economic growth outlook. Leading, coincident and lagging monetary variables are slowing sharply and in a coordinated fashion at a time when access to finance is becoming more difficult and more expensive.

On 16 March 2023, ECB President Lagarde commented that, “we are beginning to see the transmission of our monetary policy.” Eleven days later, the money sector is adding the important detail – increased stresses for banks, households and the economic outlook for the euro area.

Will the “data dependent” central bank listen to its money sector and, if so, how will it respond? The risks of policy mistakes are rising as quickly as money and credit cycles are falling…

Still tightening as stresses mount

According to the latest ECB “Monetary Developments in the euro area” data release (27 March 2023), growth in broad money (M3) fell to 2.9% YoY in February 2023, down from 3.5% in January 2023 and 4.1% in December 2022. February’s growth rate was the slowest since October 2014.

The sharp slowdown in narrow money (M1) is a key driver here. Recall that at the point of the January 2021 peak in M3 growth (12.5%), M1 contributed 11.3ppt to this total growth in broad money (see chart above).

This reflected the fact that households (HHs) and corporates (NFCs) were hoarding cash, largely in the form or overnight deposits, despite the fact that they were only earning a return of 0.01%. In stark contrast, narrow money fell -2.7% YoY in February 2023 as overnight deposits fell -2.7% YoY.  

As money supply growth slows sharply, the message from the money sector behind these headline figures contains three key warning signs for the ECB and for investors in the region.

Warning sign #1 – banks’ top line growth

Banks continue to experience net outflows of ST liabilities and a substitution away from low-cost overnight deposits to more expensive “other ST deposits”, at the margin. Continuing the theme from “Competing for funding”, EA banks have experienced outflows of ST liabilities in four of the past five months. This reflects six consecutive months of overnight deposits outflows (the blue columns in the chart above). Inflows in other ST deposits (within M2-M1 above) and, to a lesser extent, marketable securities (within M3-M2) have not been able to compensate. They also come at a higher cost.

At the same time, credit growth is slowing. Adjusted private sector credit (PSC) growth peaked recently at 7.1% YoY in September 2022. NFC credit grew 8.9% at this point and made the largest contribution to total loan growth (3.5ppt). HH credit grew 4.4% and contributed 2.3ppt.

By February 2023, PSC growth had slowed to 4.3% YoY. NFC credit growth slowed to 5.7%, but remained the largest contributor to total PSC growth (2.2ppt). HH credit growth slowed to 3.2% YoY, a 1.7ppt contribution to total PSC growth.

Warning sign #2: house prices and household consumption

Monthly flows of mortgage and consumer credit have slowed sharply to below pre-pandemic levels.Monthly mortgage flows slowed to €5.1bn in February 2023, from €13.7bn a year ago (see chart above). Note that the growth in the outstanding stock of EA mortgages peaked at 5.8% in August 2021 and slowed noticeably after June 2022. February’s growth rate was 3.7% YoY, the slowest growth rate since November 2019.

Monthly consumer credit flows fell to €1.9bn in February 2023 from €3.4bn a year earlier (see chart above). Note that while consumer credit flows have recovered, they have remained below the average pre-pandemic flows of €3.4bn throughout the post-pandemic period. This is in contrast to trends observed in the US and the UK.

With monthly mortgage and consumer credit flows falling to 0.30x and 0.33x their respective pre-pandemic average monthly flows(see chart above), the EA money sector is sending clear warning signs for future house prices and HH consumption in the region.

Warning sign #3 (re-enforced): weakening economic growth outlook

Leading, coincident and lagging monetary variables are slowing sharply and in a coordinated fashion at a time when access to finance is becoming more difficult and more expensive. Real growth rates in M1, HH credit and NFC credit typically display leading, coincident and lagging relationships with real GDP. The sharp and coordinated slowdown in these variables has been sending warning signs from some months now. If historic relationships between these variables continue, this suggest that economic activity will decelerate over the next quarters.

Conclusion

On 16 March 2023, ECB President Lagarde commented that, “we are beginning to see the transmission of our monetary policy.” Eleven days later, the money sector is adding the important detail – increased stresses for banks, households and the economic outlook for the euro area.

Will the “data dependent” central bank listen to its money sector and, if so, how will it respond? The risks of policy mistakes are rising as sharply as money and credit cycles are falling…

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