The key chart
Trends in private sector financing flows (Eur bn, 12m cum flow) and nominal NFC and HH borrowing costs (%, RHS) (Source: ECB; CMMP)
The key message
The ECB is celebrating that monetary policy transmission is working and delivering results that are EXACTLY [my emphasis] what they wanted to see. These results include:
- An increase in the cost of borrowing for EA corporates (5.26%) and households (3.91%) to their highest levels since November 2008 and June 2009 respectively
- Increases in the cost of borrowing for both sectors (343bp, 194bp) that exceed those achieved during the previous 2005-08 tightening cycle (212bp, 179bp) and that have been delivered in half the time (16 months versus 32 months)
- The highest real cost of borrowing for EA corporates (2.3%) since April 2016/September 2014
- A collapse in financing flows to the EA private sector from €764bn a year ago to repayments of €5bn now
The risks that the ECB’s celebrations might be premature are obvious, however, or at least they should be (see key chart above):
- While monetary policy transmission is working as textbooks suggest, both the pace and scale of current tightening is unprecedented
- The ECB lacks a specific playbook for such a scenario and EA economies now find themselves in uncharted territory
- Policy tightening continued even as the EA money sector was indicating increased stresses for banks, HHs and NFCs
- The end result – a combination of NEGATIVE financing flows, historic high policy rates and elevated costs of borrowing – is unlikely to be sustainable
In short, the ECB may be celebrating but the risks of policy errors remain elevated and continue to mount. The old adage, “be careful what you wish for” springs to mind…
This is exactly what we (the ECB) wanted to see
“What we are seeing is that monetary policy transmission is working. There has been a sharp increase in lending rates and a strong slowdown in loan growth. This is exactly what we wanted to see.”
Isabel Schnabel, ECB Executive Board Member, 1 December 2023
Trends in private sector financing flows (Eur bn, 12m cum flow) and nominal NFC and HH borrowing costs (%, RHS) (Source: ECB; CMMP)
In response to a 1 December 2023 interview question about the risk that the rapid drop in credit demand could exacerbate the downturn in the euro area, ECB Executive Board member, Isabel Schnabel, chose to celebrate the sharp increase in lending rates and the strong slowdown in loan growth instead. She stated that, “This is EXACTLY [my emphasis] what we wanted to see” and suggested that this proved that “monetary policy transmission is working”.
So what exactly are we/they celebrating and is there a risk that monetary policy transmission is working too well?
Trend in composite cost-of-borrowing for EA corporates (%) (Source: ECB; CMMP)
First, the composite costs-of-borrowing (CCOB) for NFCs and HHs have risen to their highest levels since November 2008 and June 2009 respectively. The CCOB for new NFC loans increased to 5.26% in October 2023, up 17bp from the previous month (5.09%). In November 2008, this cost was 5.47% (see chart above).
The CCOB for new loans to HHs for house purchases also increased to 3.91% in October 2023, up 2bp from the previous month (3.89%). This is the highest level since June 2009 (see chart below).
Trend in composite cost-of-borrowing for EA households (%) (Source: ECB; CMMP)
Second, these borrowing costs have increased more than in previous tightening cycles and in half the time. The rapid transmission of policy rates to the cost of borrowing is a key and unprecedented feature of the current ECB tightening cycle (see chart below).
Change in NFC and HH cost of borrowing since tightening began plotted against months since tightening began (Source: ECB; CMMP)
The CCOBs for NFCs and HHs have risen by 343bp and 194bp respectively in the 16 months since June 2022. Over the same time period during the 2005-08 tightening cycle, these borrowing costs rose by 133bp and 106bp respectively (see chart below). The current increases exceed the total increases that occurred during the 32 months of this previous cycle (212bp and 179bp respectively).
Trends in NFC and HH costs of borrowing (%, real terms) (Source: ECB; CMMP)
Third, the cost of NFC borrowing in real terms has reached its highest level since April 2016 and September 2014. The real cost of NFC borrowing has increased to 2.3% (see chart above). For reference, real NFC borrowing costs peaked previously at 3.1% in January 2015 and 3.7% in Juley 2009 (see graph above).
The real cost of HH borrowing has increased to 1.0%, its highest level since December 2020, but remains well below the previous, recent peaks of 3.0% in January 2015 and 4.5% in July 2009.
The collapse in financing flows to the EA private sector (Source: ECB; CMMP)
Fourth, cumulative 12-month financing flows to the private sector fell to NEGATIVE €5bn in October 2023, down from €764bn a year earlier. As noted in “Disappearing private sector financing flows – Part 1”, this represented the second consecutive month of negative financing flows, after the negative €33bn in September.
Trends in private sector financing flows (Eur bn, 12m cum flow) and real NFC and HH borrowing costs (%, RHS) (Source: ECB; CMMP)
The risks that the ECB’s celebrations might be premature are obvious, however, or at least they should be (see key chart above):
- While monetary policy transmission is working as textbooks suggest, both the pace and scale of current tightening is unprecedented
- The ECB lacks a specific playbook for such a scenario and EA economies find themselves in uncharted territory
- Policy tightening continued even as the EA money sector was indicating increasing stresses for banks, HHs and NFCs
- The end result – the current combination of NEGATIVE financing flows, historic high policy rates and elevated costs of borrowing – is unlikely to be sustainable
In short, the ECB may be celebrating but the risks of policy errors remain elevated and continue to mount. The old adage, “be careful what you wish for” springs to mind…
Please note that summary comments and charts above are abstracts from more detailed analysis that is available separately.