The key chart
The key message
Should investors positioned for an upturn in inflation and sustained outperformance from cyclical and value plays and/or shorter duration trades be hoping for stronger or weaker money supply growth in the UK and EA in 2021?
Contrary to the popular narrative, the answer is likely to be the latter not the former. In this post, I summarise why this is the case and highlight the three key charts to follow in 2021.
Over the past decade, we have witnessed a sustained shift in the components of broad money supply (M3) with greater contribution coming from holdings of the most liquid assets ie, narrow money (M1). The reaction of UK and EA households to the COVID-19 pandemic has accelerated this trend, as levels of forced and precautionary savings have risen sharply, particularly in the UK.
The challenge for inflation hawks here is that money sitting idly in savings accounts contributes to neither GDP nor inflation.
Analysis of the counterparts of monetary aggregate highlights the extent to which money and credit cycles are diverging in both regions. Within subdued overall levels of private sector credit demand, relatively robust NFC credit and resilient mortgage demand offset weakness in consumer credit during 2020. Weakness in consumer credit was more noticeable in the UK, where net repayments of £17bn made 2020 the weakest year for consumer credit on record.
There are three key signals among the messages from the money sector in 2021 to look for:
- First, a moderation in monthly deposit flows
- Second, a re-synching of money and credit cycles
- Third, a recovery in consumer credit.
Trends in 2020, suggest that the UK has a relatively high gearing to each of these trends.
The charts that mattered in 2020
Over the past decade, we have witnessed a sustained shift in the components of broad money supply (M3) with greater contribution coming from holdings of the most liquid assets ie, narrow money (M1). At the end of 2010, M1 accounted for 46% and 51% of M3 in the UK and EA respectively. By the end of 2020, these shares had risen to 67% and 71% respectively (see chart above).
In other words, changes in holdings of notes and coins and overnight deposits are having a greater impact on the behaviour of money supply. As noted in, “The yawning gap”, for example, M1 contributed 10.7ppt to the 12.3% growth in EA M3 in 2020.
The reaction of UK and EA households to the COVID-19 pandemic has accelerated this trend, as levels of forced and precautionary savings have risen sharply.
The first COVID-related death in the UK was recorded on 5 March 2020 and the first lockdown began 18 days later on the 23 March 2020. UK households increased their money holdings by £14bn, £17bn and £27bn in March, April and May 2020 respectively. This £58bn increase in holdings was greater than the total flow of £55bn recorded in 2019. Households began to increase then money holdings sharply again in October 2020, even though the second lockdown did not come into effect until 5 November 2020. In the last three months, UK households increases their money holdings by £13bn, £18bn and £21bn (£52bn in total), 3-4x the average monthly flows in 2019 (see chart above).
Similar household behaviour was seen in the euro area albeit with slightly different timings and scale. In the early stage of the pandemic, household deposits increased by €78bn and €75bn in March and April 2020 respectively, more than double the average 2019 monthly flows. In November and December 2020, monthly flows increased again to €61bn and €53bn (see chart above).
The challenge for inflation hawks here is that money sitting idly in savings accounts contributes to neither GDP nor inflation.
Analysis of the counterparts of monetary aggregate highlights the extent to which money and credit cycles are diverging in both regions. As noted last month, in typical cycles, monetary aggregates and their key counterparts move together. Money supply indicates how much money is available for use by the private sector. Private sector credit indicates how much the private sector is borrowing.
At the end of 2019, the gap between the growth in lending and the growth in money supply was 0.6ppt and -2ppt in the UK and EA respectively. By the end of 2020, these gaps had widened to record levels of -9.9pt and -7.6ppt (see chart above). Simply put, credit demand has remained relatively subdued in both regions, despite the low cost of borrowing, while money supply has accelerated.
Within subdued overall levels of private sector credit demand, relatively robust NFC credit and resilient mortgage demand offset weakness in consumer credit during 2020 in both regions (see chart above). The YoY growth in NFC credit in the UK increased from 3.3% in 2019 to 7.7% in 2020. Similarly, the respective growth rates in the EA increased from 3.2% in 2019 to 7.0% in 2020. Mortgage growth in the UK moderated slightly from 3.4% in 2019 to 3.0% in 2020 but rose from 3.9% in 2019 to 4.7% in 2020 in the EA. Consumer credit grew 6.1% and 6.0% in the UK and EA in 2019 respectively, but fell 7.5% and 1.6% in 2020 respectively.
The weakness in consumer credit was more significant in the UK than in the EA. Net repayments of £17bn made 2020 the weakest year for consumer credit on record. UK households repaid consumer credit in the last four months of 2020 and the annual growth rate of minus 7.5% represented the weakest rate of growth since the series began in 1994 (see first of the charts above). EA households also repaid consumer credit in three of the last four months of 2020, but the YoY decline of minus 1.6% was more moderate than in the UK.
Conclusion and three charts to watch in 2021
A sustained upturn in inflation and outperformance from cyclical and value sectors and shorter duration trades will require confidence, consumption and investment to return fully. There are three key signals to look for in the messages from the UK and EA money sectors in 2021.
First a moderation in monthly deposit flows, especially by the household sector, and slower growth in narrow money (M1) and hence broad money (M3).
Second, a re-synching of money and credit cycles with a corresponding rebalancing in the counterparts of broad money growth.
Third, and finally, a recovery in consumer credit. Consumer credit represents one section of COCO-based lending (see “Fuelling the FIRE”). Its supports productive enterprises since it drives demand for goods and services, hence helping NFCs to generate sales, profits and wages.
The relative scale in the shift of money holdings and weakness in consumer credit suggests that the UK has a higher gearing than the EA to a reversal of 2020’s COVID-19 induced dynamics. Watch this space in 2021…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.