Tag: #ecb

“Enough is enough”

Growth in the wrong type of lending triggers ECB call for policy shift

The key chart

Growth rates (% YoY) in average RRE prices and loans for house purchase (Source: ECB; CMMP)

The key message

In its latest “Financial Stability Review” (November 2021), the ECB calls for a policy shift away from short term support measures towards “mitigating risks from higher medium term financial stability vulnerabilities, in particular emerging cyclical and real estate risks.”

This is a welcome development given the extent to which (unorthodox) policy measures have fuelled growth in the “wrong type of lending” to date, and the negative implications this has for future growth, leverage, financial stability and income inequality.

Macroprudential instruments include capital measures (e.g. higher risk weights) and borrower-based measures (e.g. LTV limits). Their adoption varies across the euro area currently, with six economies adopting a combination of both instruments, nine economies adopting borrower-based measures alone, and four economies having no measures in place (Germany, Spain, Italy and Greece).

Further tightening of existing instruments may be required in several economies where RRE vulnerabilities are continuing to build up, but Germany stands out given current house price and lending dynamics, the extent of RRE overvaluation and the absence of targeted macroprudential measures.

“Enough is enough”

Over the past two years, I have been highlighting the hidden risk that unorthodox monetary policies in the euro area (and elsewhere) were fuelling growth in the “wrong type of lending”. From this, I have argued that the resulting shift from productive COCO-based lending towards less-productive FIRE-based lending (see chart below) has negative implications for leverage, growth, financial stability and income inequality in the future.

Outstanding stock of private sector lending (EUR bn, LHS) broken down by type and share of FIRE-based lending in total lending (%, RHS) (Source: ECB; CMMP)

Earlier this month, I also argued that it was appropriate, therefore, to expect new macroprudential measures for residential real estate soon. The ECB agrees (finally). In their latest “Financial Stability Review” (November 2021), the ECB is calling for a policy shift away from short-term support towards mitigating risks from higher medium-term financial stability vulnerabilities including residential real estate (RRE) risks.

2Q21 RRE price growth (% YoY) plotted against level of pre-pandemic valuation (Source: ECB; CMMP)

The ECB’s analysis includes three key risk factors:

  • First, nominal house prices grew at 7.3% in 2Q21, the fastest rate of growth since 2005 (see key chart above)
  • Second, house price and lending dynamics have been much stronger in many countries with pre-existing vulnerabilities. For example, despite above average degrees of over-valuation pre-pandemic (ie, >4% estimated overvaluation), RRE prices grew at above-average rates (ie, >7% YoY) in Luxembourg, the Netherlands, Austria, Germany, and Belgium in the year to end 2Q21 (see chart above)
  • Third, there is evidence of a progressive deterioration in lending standards, as reflected in the increasing share of loans with high LTV ratios. The share of new loans with LTVs above 90% reached 52% in 2020 compared with only 32% in 2016 (see chart below)

The ECB also notes “high and rising levels of HH indebtedness”, but this is less of a risk, in my opinion, given that the HH debt ratio of 61% GDP is well below the BIS’ threshold of 85% GDP.

Share of loans with LTV >90% in total new loan production (Source: ECB; CMMP)

Macroprudential instruments include capital measures (eg higher risk weights) and borrower-based measures (eg, LTV limits). Their adoption varies across the euro area with six economies adopting a combination of both instruments (green bubbles in chart below), nine economies adopting only borrower-based measures (orange bubbles in chart below), and four economies having no measures in place – Germany, Spain, Italy and Greece (red bubbles in chart below, although Greece not shown).

RRE price growth plotted against mortgage loan growth 1H21 v 1H20. Size of bubbles represents HH debt ratio and colour represents current macroprudential framework (Source: ECB; CMMP)

Further tightening of existing instruments may be required in several economies where RRE vulnerabilities are continuing to build up, but Germany stands out given the combination of house price and lending dynamics, the extent of overvaluation and the lack of macroprudential measures.

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

“Little cheer yet…”

Key signals revisited in February

A short key message

Broad money (M3) rose 12.3% YoY across the euro area (EA) in February 2021, down slightly from the 12.5% and 12.4% growth rates recorded in January 2021 and December 2020 respectively. Narrow money (M1) grew 16.4% YoY, versus 16.5% in January, and contributed 11.3ppt to overall money growth. Overnight deposits, the key component of M1, rose 17.0% YoY and contributed 10.1ppt to overall money growth alone.

In relation to three key signals framework introduced early this year that look for (1) a moderation in monthly deposit flows, (2) a re-synching of money and credit cycles, and (3) a recovery in consumer credit – there is little change to report in these numbers:

  • Households placed €53bn in deposits in February, down from €61bn in January but in-line with the €54bn deposited in January. February’s monthly flow is still 1.6x the average monthly flows recorded in 2019 indicating that the preference for holding highly-liquid assets and household uncertainty levels remain high
  • Money and credit cycles remain out-of-synch. Private sector credit grew 4.5% YoY in February, unchanged from January, but 7.8ppt slower than the 12.3% growth in broad money. This is the second highest gap between credit growth and money growth after last month’s 8ppt. Note that from a counterparts perspective, credit to the private sector contributed only 5.3ppt to broad money growth versus 8.6ppt from credit to general government.
  • Consumer credit remains weak. While the monthly flow of consumer credit was a positive €2bn, versus net repayments of €3bn in January, the YoY grow rate fell to a new low of -2.8%.

So no change in the messages from the money sector. Household uncertainty and liquidity preference remains elevated, money and credit cycles remain out-of-synch and consumer credit continues to weaken.

Little cheer yet for investors positioned for an upturn in EA inflation.

“Hawks vs Doves – part 1”

Look beyond the headines and a different story emerges

The key chart

Growth in broad money (% YoY) since 1981 (Source: ECB; CMMP)

The key message

Inflation hawks in the euro area may cheer January’s record 12.5% YoY growth in broad money, but doves will take comfort from what is happening behind the headlines.

  • There is no sign of a moderation in household (HH) monthly deposit flows – January’s flows (€60bn) remain almost 2x the 2019 average and money sitting idly in savings accounts contributes to neither GDP nor inflation (n.b. growth in overnight deposits contributed 10.1ppt to overall money growth)
  • The gap between the money and credit cycle widened to a new high of 8.1ppt compared with 1.5ppt a year earlier. Credit demand remains subdued, despite the low cost of borrowing, while money supply accelerated. This is not a typical cycle
  • Finally, the region’s HHs have paid down consumer credit in four of the past five months. January’s -2.5% YoY change in consumer credit was the weakest level since February 2014

There is nothing in today’s data to change the pre-existing narrative. At the end of January, the score is 3:0 to the doves.

Three key charts for 2021 revisited

Inflation hawks in the euro area may cheer January’s record growth in broad money. M3 grew 12.5% YoY in January, from 12.4% in December 2020 and 11.0% in November 2020. This is the fastest rate of growth in the ECB’s current data series extending back to 1981 (see key chart above) and matches the previous peak level recorded in October and November 2007. Growth in narrow money (M1) also hit a new high (16.4% YoY) and contributed 11.3ppt to the total growth in M3. Within M1, overnight deposits grew 17.1% YoY and contributed 10.1ppt to the total growth in M3 alone. At this point, inflation hawks might begin to wonder…

Inflation doves, in contrast, will take comfort from what is happening behind the headlines. Earlier this month, I suggested that there were three key signals among the messages from the money sector to look for in 2021:

  • First, a moderation in monthly deposit flows
  • Second, a re-synching of money and credit cycles
  • Third, a recovery in consumer credit

Key signal #1

Monthly flows of HH deposits as a multiple of the 2019 average monthly flow (Source: ECB; CMMP)

Euro area HHs deposited €60bn in January, 1.8x the average 2019 monthly flow of €33bn. In the past three months, HH monthly flows have increased by €61bn (1.9x), €52bn (1.6x) and €60bn (1.8x) suggesting that HH uncertainty levels remain elevated. NFC monthly deposits of €22bn in January were also 1.7x their respective 2019 average. The key point here is that money sitting idly in savings accounts contributes to neither GDP nor inflation.

Key signal #2

Growth (% YoY) in private sector credit minus growth in M3 (Source: ECB; CMMP)

The gap between the money and credit cycle widened even further in January. Private sector credit (a key counterpart to M3) grew by 4.4% YoY on an adjusted basis, down from 4.7% in December, and contributed only 5.4ppt to the growth in broad money (versus 5.7ppt in December). The difference between the growth in lending and the growth in money supply is now a new record of 8.1ppt. This compares with 1.5ppt a year earlier. Note that, in typical cycles, monetary aggregates and their 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. The key point here is that credit demand remains relatively subdued, despite the low cost of borrowing, while money supply has accelerated. This is not a typical cycle.

Key signal #3

Monthly consumer credit flows (EURbn) and growth rates (% YoY) (Source: ECB; CMMP)

HHs repaid €2.5bn in consumer credit in January 2021 and the YoY growth rate fell to -2.5%, the weakest level since February 2014. Recall that consumer credit represents one section of COCO-based lending. It supports productive enterprise since it drives demand for goods and services, hence helping NFCs to generate sales, profits and wages. With HHs hoarding cash and lockdown measures remaining in place, weakness in consumer credit is not unexpected.

Conclusion

While inflation hawks may cheer accelerating growth in EA broad money, doves will correctly look beyond the headlines to note that HHs remain uncertain and continue to hoard cash, the gap between the money and credit cycle has widened even further and consumer credit trends remain weak. As yet, there is nothing in the messages from the money sector, to change the pre-existing narrative. At the end of January, the score is 3:0 to the doves.

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

“The long and uncertain road to recovery”

July’s message from the EA money sector

The key chart

Unusually high monthly flows into O/N deposits (despite negative real rates of return) indicate elevated levels of uncertainty among HHs and NFCs in the euro area (Source: ECB; CMMP analysis)

The key message

July’s monetary developments in the euro area suggest that the road to recovery will be long and uncertain. Broad money (M3) is growing at the fastest rate (10.2% YoY) since May 2008. Growth rates in the components of M3 indicate that uncertainty remains very elevated at the start of 3Q20. Overnight deposits, for example, contributed 8.3ppt to the growth in broad money alone (despite negative real returns). July’s overnight deposit inflow of €151bn was the second largest inflow after March’s €249bn and was 3x the 2019 average. In contrast, growth rates in the counterparts to M3 indicate that HH consumption is recovering and the NFC’s record “dash-for-cash” has peaked. However, before anyone gets too excited – the gap between subdued PSC growth (debt overhang?) and rapid M3 growth (elevated uncertainty?) hit a twenty-year peak in July.

In short, July’s message from the EA money sector is simple: the peak of the crisis may have passed but the road to recovery is likely to be long and uncertain.   

The long and uncertain road in charts

Growth rates in broad (M3) and narrow (M1) money in the euro area (% YoY) – July’s M1 growth rate exceeded 2009 and 2015 peaks (Source: ECB; CMMP analysis)

July’s monetary developments in the euro area (EA) suggest that the road to recovery will be a long and uncertain one. Broad money (M3) grew by 10.2% YoY in July from 9.2% in June, the fastest rate of growth since May 2008.

Drivers of M3 growth (percentage points) – overnight deposits (8.3ppt) remain the key driver of M3 (Source: ECB; CMMP analysis)

Narrow money (M1) grew by 13.5% YoY in July from 12.6% in June, faster than the 13.1% (Aug 09) and 11.7% (July 15) peak growth rates recorded during the GFC and after the euro crisis. M1 growth contributed 9.2ppt to the total 10.2% growth in broad money. Within M1, overnight deposits grew 14.1% YoY and contributed 8.3ppt to the overall growth in M3 alone.

Growth rates in mortgage, consumer and corporate credit – passed the crisis peaks and troughs? (Source: ECB; CMMP analysis)

Adjusted loans to the private sector grew 4.7% YoY, slightly below the 4.8% recorded in June. The annual growth rate in loans to households (HHs) was unchanged at 3.0% while the equivalent growth rate in loans to corporates (NFCs) fell very slightly to 7.0% from 7.1%. No surprises here – above trend NFC credit and resilient HH mortgage demand continue to offset weakness in HH consumer credit.

An “old favourite” chart – the gap between the growth rates in PSC and M3 is at a new twenty-year peak (Source: ECB; CMMP analysis)

The gap between the growth in money supply (M3) and the growth in private sector credit (PSC) increased to 5.5ppt, a twenty year high. This reflects the combination of extraordinary uncertainty (driving M3) and the limited progress in dealing with the debt overhang in the EA (subduing PSC).

Monthly flows into O/N deposits since January 2019 – a surprise jump in July? (Source: ECB; CMMP analysis

The monthly flow data once again provides a more nuanced picture than the headline annual growth trends. Overnight deposits, which contributed 8.3ppt to the overall growth in M3 alone, rose by €151b. This represents the second largest monthly inflow of overnight deposits (after €249bn in March 2020).

Monthly deposit flows from HHs and NFCs since January 2019 (Source: ECB; CMMP analysis)

July’s data includes a €58bn swing from negative to positive flows from non-monetary financial corporations – n.b. these flows are typically more volatile than HH and NFC flows. That said, monthly flows by HHs and NFCs also increased MoM to levels 24% and almost 50% above the average 2019 inflows. Put simply, these trends suggest that HH and NFC uncertainty levels remain very elevated.

Monthly trends in HH credit demand – passed the low point? (Source: ECB; CMMP analysis)

On a more positive note, mortgage demand remains resilient and consumer credit has recovered. Loans for house purchase increased by €19b in July versus 9€10bn in June and above the average €14bn monthly flow recorded in 2019. After record repayments between March and May 2020, monthly flows of credit for consumption have exceeded €3bn for two months in a row, closing on the €3.4bn monthly average in 2019. NFC lending data suggests that we passed the peak “dash for cash” in March and April, although July’s monthly flow of almost €16bn remains above the 2019 average of €12bn.

Putting the NFC “dash-for-cash” into an historic context (Source: ECB; CMMP analysis)

Conclusion

The message from the money sector at the start of the 3Q20 is a mixed one. Growth rates in the components of M3 indicate that uncertainty remains very elevated. In contrast, growth rates in the counterparts to M3 indicated that HH consumption is recovering and the NFC dash-for-cash has peaked. In short, while the peak of the crisis appears to have passed, the road to road to recovery is likely to remain a long and uncertain one.

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