The key chart
The key message
The EA may be leading the UK in a steady and synchronised recovery but this is not the time to repeat the post-GFC policy mistakes.
What are the euro area (EA) and UK money sectors telling us about the nature of the recovery from the COVID-19 pandemic?
The deflationary forces that drove the acceleration in broad money during the pandemic have peaked. Household (HH) uncertainly is falling, especially in the EA (key signal #1). Monthly flows in consumer credit were positive in May in both regions and the EA registered positive YoY growth in consumer credit for the second month running (key signal #2).The gap between lending growth and money growth is narrowing from recent record highs but both regions remain a long way from normalised money and credit cycles (key signal #3).
The 2Q21 message from the money sector is clear – the EA is leading the UK in a steady and synchronised recovery from the COVID-19 pandemic (so far), but with a challenging policy context looking forward. The comments from ECB Executive Board member, Fabio Panetta, that, “Combined fiscal and monetary support has lifted the economy out of the state of the emergency” appear well founded in this context.
The tentative nature of the recovery to date places even more importance on Panetta’s conclusion that, “We cannot waste the opportunity of having, for the first time in more than a decade, a combination of expansionary monetary and fiscal policies and a global reflationary environment to re-anchor inflation expectations to our target.”
This is not the time to repeat the post-GFC policy mistakes.
2Q21 messages from the money sectors
The deflationary forces that drove the acceleration in broad money during the pandemic have peaked. As can be seen in the chart above, narrow money (notes and coins in circulation and overnight deposits, or M1) represents an increasingly large proportion of broad money (M3) in both regions.
In May 2021, M1 accounted for 72% and 68% of M3 in the EA and UK respectively. This compares with 45% and 47% respectively in May 2009 and the GFC period. The key point here is that money sitting idly in overnight deposits contributes to neither growth nor inflation.
As noted in previous posts (see “Don’t confuse the message”), it is important not to confuse the messages from the pre-GFC and COVID-19 periods of broad money expansion (see EA chart above). The message from the former period was one of over-confidence (low M1 contribution) and excess credit demand (high PSC contribution). In contrast, the recent message has been one of heightened uncertainty (high M1 contribution) and subdued credit demand (low PSC contribution). In short, recent money growth reflects fiscal and monetary easing in response to weak private sector demand and rising savings (with the added uncertainty regarding the extent to which rising savings are forced or precautionary).
Key signal #1 revisited
HH uncertainly is falling, especially in the EA (key signal #1). Monthly HH deposit flows are moderating in both regions. During the pandemic, HHs in both regions increased their money holdings despite earning negative returns – a combination of forced and precautionary savings. At their respective peaks, monthly flows were 2.4x (March 2020) and 6.0x (May 2020) their pre-Covid levels in the EA and UK respectively (see chart above).
In the EA, monthly flows were €31bn in May (up from €20bn in April) compared to the €33bn average flows seen during 2019. This was the second consecutive month when monthly flows were below their pre-COVID levels. In the UK, monthly flows were £7bn in May 2021, down from £9bn in April 2021, but still 1.5x their 2019 average of £5bn.
Key signal #2 revisited
Monthly flows in consumer credit were positive in May in both regions and the EA registered (slightly) positive YoY growth in consumer credit for the second month running (key signal #2).
HHs in the EA and UK borrowed €1.5bn and £0.3bn as consumer credit respectively in May 2021. This is the first time since August 2020 that UK consumers have borrowed more than they paid off. The Bank of England reported that this increase reflected £0.4bn in “other” forms of consumer credit such as card dealership finance and personal loans. In contrast, credit card lending remained weak with a net repayment of £0.1bn.
The EA has registered growth rates of 0.3% and 0.6% YoY in April and May 2021. In the UK, consumer credit fell -3.2% from -5.7% in April and the historic low of -10% in February 2021.
Key signal #3 revisited
The gap between lending growth and money growth is narrowing from recent record highs but both regions remain a long way from having normalised money and credit cycles (key signal #3).
Recall that in typical cycles, monetary aggregates and their key counterparts (eg credit to the private sector) 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 actually borrowing.
The gap has narrowed to 5.7ppt in the EA and 6.9ppt in the UK from recent, record highs of 8ppt (January 2021) and 11.4ppt (February 2021) respectively. This narrowing reflects a slowdown in both money supply and private sector credit, especially in the NFC sector.
Note that: (1) the effectiveness of monetary policy relies, in part, on certain stable relationships between monetary aggregates and their counterparts; and (2) that the desynchronization of money and credit cycles during the pandemic was unprecedented in both the EA and the UK.
Conclusion
The 2Q21 message from the money sector is clear – the EA is leading the UK in a steady and synchronised recovery from the COVID-19 pandemic (so far), but with a challenging policy context looking forward.
In this context, the comments from ECB Executive Board member, Fabio Panetta, that, “Combined fiscal and monetary support has lifted the economy out of the state of the emergency” appear well founded.
The tentative nature of the recovery to date places even more importance on Panetta’s conclusion that, “We cannot waste the opportunity of having, for the first time in more than a decade, a combination of expansionary monetary and fiscal policies and a global reflationary environment to re-anchor inflation expectations to our target.”
This is not the time to repeat the post-GFC policy mistakes.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.