How will the “data-dependent” ECB respond to slowing money and credit cycles?
The key chart
Growth rates in EA broad money, narrow money and private sector credit (% YoY, nominal) (Source: ECB; CMMP)
The key message
The message from the euro area (EA) money sector is increasingly challenging for the “data-dependent” ECB.
The EA money and credit cycles are rolling over rapidly – the annual growth rate in narrow money fell -0.7% YoY in January, for example. Leading, coincident and lagging monetary variables are all sending negative messages for the region’s growth outlook.
Monthly household (HH) lending flows are slowing sharply for both mortgages and consumer credit. A clear warning sign for future house prices and HH consumption in the region.
With inflation still running well above target at 8.6% YoY in January 2023, the ECB remains committed to a further 50bp increase in rates in March, however. The ECB’s foot remains firmly on the brake pedal as the money sector warns of slowing economic growth.
Positive “cold-water therapy” is increasing looking like a less attractive cold shower.
Rolling over, rapidly
The EA money and credit cycles are rolling over rapidly (see key chart above). The annual growth rate in broad money (M3) fell to 3.5% YoY in January 2023, from 4.1% in December 2022 and 6.5% a year earlier. The annual growth rate in narrow money (M1) actually declined -0.7% YoY in January 2022, from 0.6% in December 2022 and 9.2% a year earlier.
Trends in broad money growth (% YoY) and contribution from overnight deposits (ppt) (Source: ECB; CMMP)
Recall that growth in narrow money was the key driver in the recent expansion in total EA money supply (see chart above). This reflected the hoarding of cash, largely in the form of overnight deposits at banks, by the regions household (HH) sector. Note, however, that monthly flows of HH overnight deposits have been negative since October 2022.
Trends in annual growth rates of M1, HH credit and NFC credit (% YoY, real terms) (Source: ECB; CMMP)
Leading, coincident and lagging monetary variables are all sending negative messages for the region’s growth outlook. Real growth rates in M1, HH credit and corporate (NFC) credit typically display leading, coincident and lagging relationships with real GDP growth over time. Growth rates in all of these variables peaked some time ago and are current negative in real terms: -8.6% YoY for real M1; -4.6% YoY for real HH credit; and -2.3% YoY for real NFC credit.
Monthly household (HH) lending flows are slowing sharply for both mortgages and consumer credit. Monthly mortgage flows slowed to €1.9bn in January 2022, down from €26.7bn a year earlier and a recent peak of €30.1bn in June 2022 (see chart above). Similarly, monthly consumer credit flows fell to €0.3bn in January 2023, down from €1.1bn a year earlier and a recent peak of €3.4bn in February 2022 (see chart below). A clear warning sign for future house prices and HH consumption in the region.
With inflation still running well above target at 8.6% YoY in January 2023, the ECB remains committed to a further 50bp increase in rates in March, however. The ECB’s foot remains firmly on the brake pedal as the money sector warns of slowing economic growth.
Positive “cold-water therapy” is increasing looking like a less attractive cold shower.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Mortgage flows slowing at a faster rate in the EA than in the UK
The key chart
Monthly mortgage flows (3m MVA) expressed as a multiple of pre-pandemic average flows (Source: BoE, ECB; CMMP)
The key message
November 2022 monthly mortgage flows point to a synchronised slowdown in mortgage demand in the UK and EA, but with a sharper rate of decline in the EA (driven by German and French dynamics). Mortgage demand typically displays a co-incident relationship with GDP growth. In this context, turning points are more significant than the rate of change. The key message here relates more to a synchronised slowdown in economic activity in both regions, therefore, rather than “point-scoring” between them!
Synchronised slowdowns?
Trends in UK monthly mortgage flow (£bn, LHS) and annual growth (% YoY, RHS) (Source: BoE; CMMP)
Monthly UK mortgage flows rose to £4.4bn in November 2022, up from £3.6bn in October 2022. While this is well below the recent peak flow of £17bn in June 2021, it is above the pre-pandemic average flow of £3.9bn.
According to the latest, Bank of England data release (4 January 2022), approvals for house purchase, an indicator of future borrowing, decreased from 57,900 in October 2022 to 46,100 in November 2022, the lowest level since June 2020. It is reasonable, therefore, to expect lower UK flows in coming months.
Mortgage flows are slowing at a faster rate in the EA than in the UK. The 3m MVA of monthly mortgage flows in the EA has fallen from 2.1x pre-pandemic flows in July 2022 to 0.9x pre-pandemic flows in November 2022 (see key chart above). In contrast, UK monthly flows remain above pre-pandemic levels on a monthly basis (1.1x) and a smoothed basis (1.2x).
Mortgage demand typically displays a co-incident relationship with GDP growth. In this context, turning points are more significant than the rate of change. So, as above, the key message here relates more to a synchronised slowdown in economic activity in both regions rather than “point-scoring” between them!
Please note that the summary comments above are abstracts from more detailed analysis that is available separately.
Annual growth (% YoY) in EA private sector lending split between FIRE-based and COCO-based lending (Source: ECB; CMMP)
The key message
Is the ECB correct to argue that, “monetary policy measures continue to support lending conditions and volumes” in the euro area? Yes, but only up to a point.
On the supply-side, the APP, PEPP and TLTRO III programmes are having a positive impact on banks’ liquidity positions and overall market financing conditions. On the demand side, borrowing costs are at (mortgages) or close to (NFC loans) historic lows in nominal terms and at historically low and negative levels in real terms. So far, so good.
That said, lending volumes are unexciting in relation to recent trends and previous cycles and currently negative in real terms. No compelling volume story here.
More importantly, current policy measures are supporting the “wrong type of credit”.
Less-productive lending that supports capital gains through higher asset prices (FIRE-based lending) contributed 2.5ppt to the 3.2% total loan growth in September 2021. Worryingly, this is part of longer-term trend. While the outstanding stock of private sector loans hit a new high in September, the stock of productive lending that supports production and income formation (COCO-based lending) remains below its January 2009 peak.
This matters for two key reasons. First, the shift from COCO-based lending to FIRE-based lending has negative implications for leverage, growth, financial stability and income inequality (expect new macroprudential measures for residential real estate soon). Second, it re-enforces the importance of an on-going policy response that remains “fiscal, first and foremost”.
“How much? How productive?”
In its latest “Euro area bank lending survey”, the ECB argues that, “monetary policy measures continue to support lending conditions and volumes” in the euro area (EA). Is this correct?
The supply-side
“Liquidity-providing” monetary policy operations in EUR bn (Source: ECB; CMMP)
On the supply-side, EA banks report that “the ECB’s asset purchase programme (APP), the pandemic emergency purchase programme (PEPP), and the third series of targeted longer-term refinancing operations (TLTRO III) continues to have a positive impact on their liquidity positions and market financing conditions” (see chart above).
The demand-side
Composite cost-of borrowing for house purchases and NFC loans in nominal and real terms (Source: ECB; CMMP)
One the demand side, borrowing costs are at (mortgages) or close to (NFC loans) historic lows in nominal terms and at historically low and negative levels in real terms (see chart above). In September 2021, the composite cost-of-borrowing for house purchases hit a new low of 1.30% (-2.03% in real terms). The composite cost of borrowing for NFC’s was 1.48%, 0.8ppt above its March 2021 low, but a new low in real terms (-1.86%).
How exciting is the volume story?
Annual growth (% YoY) in private sector lending in nominal and real terms (Source: ECB; CMMP)
Lending volumes are unexciting in relation to recent trends and previous cycles and currently negative in real terms. Lending to the private sector grew 3.2% YoY in September 2021 both on a reported basis and after adjusting for loan sales and securitisation. In nominal terms, lending growth has been relatively stable since March 2021 but is 2ppt lower than the recent peak growth recorded in May 2020 (5.2% YoY). Lending growth in the current cycle is relatively subdued, however, in relation to past cycles (see chart above). Furthermore, in real terms, lending in September fell slightly when adjusted for HICP inflation.
No compelling volume story here.
Loan growth from the ECB perspective
Annual loan growth with ECB breakdown by borrower (Source: ECB; CMMP)
As an aside, the ECB typically classifies lending by type of borrower – households (HHs), non-financial corporations (NFCs), non-monetary financial corporations (NMFCs) and insurance companies and pension funds (ICPFs) – with further subdivisions based in the type of HH borrowing and the maturity of NFC borrowing.
In September 2021, HH lending contributed 2.2pt to the total 3.2% YoY growth, essentially mortgages. NFCs and NMFCs contributed 0.6ppt and 0.5ppt respectively but lending to ICPFs made a slight negative contribution of -0.1ppt.
Loan growth from the CMMP Perspective
CMMP analysis presents an alternative classification based on the productivity of credit use. Broadly speaking, lending can be spilt into two distinct types: lending to support productive enterprise; and lending to finance the sale and purchase of existing assets. The former includes lending to NFCs and HH consumer credit (and other HH lending) and is referred collectively here as “COCO-based” lending (COrporate and COnsumer). The latter includes loans to non-bank financial institutions (NBFIs) and HH mortgage or real estate debt and is referred collectively here as “FIRE-based” lending (FInancials and Real Estate).
Note that COCO-based lending typically supports production and income formation while FIRE-based lending typically supports capital gains through higher asset prices.
Supporting the “wrong type of credit”
Annual loan growth with CMMP breakdown by productivity of use (Source: ECB; CMMP)
Viewed from a CMMP perspective, current policy measures are supporting the “wrong type of credit”. Less-productive lending that supports capital gains through higher asset prices (FIRE-based lending) contributed 2.5ppt to the 3.2% total loan growth in September 2021 (see chart above).
Annual loan growth broken down by productivity of use since September 2006 (Source: ECB; CMMP)
Worryingly, this is part of a longer-term trend. As can be seen from the chart above, higher volumes in the pre-GFC period were more balanced with more-productive COCO-based lending accounting for 56% of total outstanding loans. Today, that share has fallen to 48%.
Outstanding stock (EUR bn) of COCO-based lending (Source: ECB; CMMP)
As noted in August 2021, while the outstanding stock of credit hit a new high in September, the stock of productive COCO-based lending (€5,470bn) remains below its January 2009 peak (€5,517bn). In other words, the aggregate growth in lending since early 2009 has come exclusively from FIRE-based lending which now accounts for 52% of the outstanding stock of loans (see chart below).
Outstanding stock (EUR bn) of COCO-based and FIRE-based lending (Source: ECB; CMMP)
Conclusion
The ECB is entitled to argue that monetary policy measures have supported lending conditions and volumes. However, current lending volumes are unexciting in relation to previous cycles and negative in real terms. Policy is also supporting the “wrong type” of credit – fuelling FIRE-based lending rather than productive COCO-based lending that supports production and income formation.
This matters for two key reasons. First, the shift from COCO-based lending to FIRE-based lending has negative implications for leverage, growth, financial stability and income inequality. During the COVID-19 pandemic, some national authorities eased macroprudential measures for residential real estate (RRE). This week, however, the ECB argued that further macroprudential measures should be considered where RRE vulnerabilities continue to build up. (Watch this space.) Second, it re-enforces the importance of an on-going policy response that remains “fiscal, first and foremost”.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Little to cheer in the message from the EA money sector
The key chart
Real YoY growth rates in total lending and total minus HH lending (Source: ECB; CMMP)
The key message
This morning’s message from the euro area (EA) money sector provided little cheer for those hoping for a refuelling boost to the region’s recovery/reflation narrative.
Broad money (M3) grew 7.9% YoY in August 2021, from 7.6% YoY in July 2021. However, with narrow money (M1) growing 11.1% YoY and contributing 7.8ppt to the total M3 growth, this marked the impact of deflationary forces rather than inflationary ones.
The monthly HH deposit flow (key signal #1) jumped to EUR51bn in August, from EUR23bn in July, and was 1.5x larger than pre-pandemic flows. Monthly consumer credit (key signal #2) fell to EUR0.1bn, in August from EUR2.0bn and EUR2.4bn in June and July respectively, leaving the YoY growth rate flat in nominal terms. Private sector credit growth slowed to 2.9% YoY in August from 3.1% YoY in July meaning that the gap between private sector credit and money growth (key signal #3) widened again to 5.0ppt in August from 4.6ppt in July – the money and credit cycles remain out-of-synch with each other.
Household credit grew 4.2% YoY in August and contributed 2.2ppt to the total 2.9% growth. Strip out HH lending, however, and private sector credit grew only 0.8% in nominal terms and fell -2.2% in real terms, the slowest rate of real growth since April 2014.
In short, it is not just the motorists queueing outside petrol stations today who are facing refuelling challenges –EA investors are too.
“Refuelling challenges” in six charts
Growth in M3 (YoY %) and contribution on M1 (ppt) (Source: ECB; CMMP)
Broad money (M3) grew 7.9% YoY in August 2021, from 7.6% YoY in July 2021. However, with narrow money (M1) growing 11.1% YoY and contributing 7.8ppt to the total M3 growth, this marked a return of deflationary forces rather than inflationary ones (see chart above).
Monthly HH deposit flows as a multiple of average 2019 monthly flows (Source: ECB; CMMP)
The monthly HH deposit flow (key signal #1) jumped to EUR51bn in August, from EUR23bn in July, and was 1.5 larger than pre-pandemic flows (see chart above). The key point here is that money sitting idly in overnight deposits contributes to neither growth nor inflation.
Monthly consumer credit (key signal #2) fell to EUR0.1bn, in August from EUR2.0bn and EUR2.4bn in June and July respectively, leaving the YoY growth rate flat in nominal terms (see chart above).
Growth in private sector credit (Source: ECB; CMMP)
Private sector credit growth slowed to 2.9% YoY in August from 3.1% YoY in July (see chart above), meaning that the gap between private sector credit and money growth (key signal #3) widened again to 5.0ppt in August from 4.6ppt in July – the money and credit cycles remain out-of-synch with each other (see chart below) creating challenges for policy makers and investors alike.
Growth in PS credit minus growth in broad money (Source: ECB; CMMP)
Household credit grew 4.2% YoY in August and contributed 2.2ppt to the total 2.9% growth (see chart below). Strip out HH lending, however, and private sector credit grew only 0.8% in nominal terms and fell -2.2% in real terms, the slowest rate of real growth since April 2014 (see key chart above).
Drivers of PSC growth by sector (Source: ECB; CMMP)
In short, it’s not just the motorists queueing outside petrol stations today who are facing refuelling challenges – EA investors are too.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Outstanding stock of COCO-based loans since 2003 in EURbn (Source: ECB, CMMP)
The key message
Bank lending to the private sector falls into two distinct types: (1) lending to support productive enterprise (“COCO-based”); and (2) lending to finance the sale and purchase of exiting assets (“FIRE-based”). While the stock of total loans to the euro area (EA) private sector hit a new high at the end of 1H21, the stock of productive COCO-based lending remains below its January 2009 peak. In other words, the (aggregate) growth in lending since January 2009 has come exclusively from FIRE-based lending. This accounts for 52% of all outstanding loans now versus 45% in January 2009.
This shift matters because while COCO-based lending supports both production AND income formation, FIRE-based lending supports capital gains through higher asset prices but does not lead directly to income generation. Neither QE nor COVID-19 caused this shift but both added momentum to it. This trend provides support for Minsky’s hypothesis that, over the course of a long financial cycle, there will be a shift towards riskier and more speculative sectors. The implications extend well beyond the over-valuation of residential property prices. Current dynamics, fuelled in part by current policy, have wider, negative implications for leverage, growth, financial stability and income inequality. Time for another policy reboot?
FIRE, FIRE – what has happened?
Outstanding stock of total loans (EURmn) split between the two forms of lending (Source: ECB, CMMP)
Bank lending to the private sector falls into two distinct types: (1) lending the support productive enterprise; and (2) lending to finance the sale and purchase of exiting assets (see chart above). The former includes lending to corporates (NFCs) and household (HH) consumer credit. Such loans are referred to collectively as “COCO-based” loans (COrporate and COnsumer). The latter includes loans to non-bank financial institutions (NBFIs) and HH mortgage or real estate. These loans are referred to collective as “FIRE-based” loans (FInancials and Real Estate).
Change in stock of loans (EURbn) by type since January 2009 (Source: ECB; CMMP)
While the stock of total loans to the euro area (EA) private sector hit a new high at the end of 1H21, the stock of COCO-based lending remains below its January 2009. Total PSC rose €1,200bn over the period to €12,071bn (see chart above). Total COCO-based loans fell -€79bn (NFC -€130bn, consumer credit €51bn). Total FIRE-based loans, in contrast, rose €1,349bn (mortgages €1,356bn, financial institutions -€55bn; insurance companies and pension funds €48bn).
Trends in stock of FIRE-based lending (EURbn) and market share of total PSC (Source: ECB; CMMP)
In other words, (aggregate) growth in lending since January 2009 has come exclusively from FIRE-based lending. In June 2021, FIRE-based lending hit a new high of €5,937bn. This is 29% higher than the January 2009 level. Its market share has increased from 45% to 52% over the period.
FIRE, FIRE – why this matters
This matters because COCO-based lending supports both production and income formation. Loans to NFCs are used to finance production, which leads to sales revenues, wages paid, profits realised and economic expansions. So while an increase in NFC debt will increase debt in the economy, it also increases the income required to finance it. Consumer debt also supports productive enterprise since it drives demand for goods and services, helping NFCs to generate sales, profits and wages, It differs from NFC debt to the extent that HHs take on an additional liability since the debt does not generate income.
In contrast, FIRE-based lending supports capital gains through higher asset process but does not lead directly to income generation. Loans to NBFIs are used primarily to finance transactions in financial assets rather than to produce, sell or buy actual output. Such credit may lead to an increase in the price of financial assets but does not lead (directly) to income generation. Mortgage or real estate lending is used to finance transactions in pre-existing assets. It typically generates asset gains as opposed to income (at least directly).
Wider implications
Growth rate (% YoY) in EA house prices (Source: Eurostat; CMMP)
Much recent attention has focused on the impact of the COVID-19 and unorthodox monetary policy on residential property prices (see “Herd immunity”). This analysis shows that the shift towards FIRE-based lending pre-dates both, however, and has much wider and negative implications for leverage, growth, financial stability and income inequality in the EA:
Leverage: while COCO-based lending increases absolute debt levels, it also increases incomes (albeit with a lag). Hence, overall debt levels need not rise as a consequence. In contrast, FIRE-based lending increases debt and may increase asset prices but does not increase the purchasing power of the economy as a while. Hence, it is likely to result in higher levels of leverage.
Growth: COCO-based lending supports growth both by increasing the value-add from final goods and services (“output”) and an increase in profits and wages (“income”). FIRE-based lending typically only affects GDP growth indirectly.
Financial stability: the returns from FIRE-based lending (investment returns, property prices etc) are typically more volatile than returns from COCO-bases lending and may affect the solvency of lenders and borrowers. In the May 2021, Financial Stability Review, the ECB noted that, “a combination of buoyant house price growth and the uncertain macro backdrop kept measures of overvaluation elevated.” Moreover, house price growth during the pandemic has generally been higher for those countries that were already experiencing pronounced overvaluation prior to the pandemic.”
Inequality: the returns from FIRE-based lending are typically concentrated in higher-income segments of the populations, with any subsequent wealth effects increasing income inequality.
Stock and market share of COCO- and FIRE-based lending (Source: ECB; CMMP)
Conclusion
Neither QE nor COVID-19 caused the shift away from productive COCO-based lending towards FIRE-based lending. Both did, however, add momentum to a pre-existing trend which has seen no growth in the stock of productive lending over the past 12 years.
This trend provides support for Minsky’s hypothesis that, over the course of a long financial cycle, there will be a shift towards riskier and more speculative sectors. The implications extend well beyond the over-valuation of residential property prices. Current private sector dynamics, fuelled in part by current policy, have negative implications for leverage, growth, financial stability and income inequality. Time for another policy reboot?
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
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.
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.
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.
PSC growth (YoY, rolling) minus M3 growth (YoY, rolling) since 1998 (Source: ECB; CMMP)
The key message
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. Today’s ECB data release reinforces the extent to which money and credit cycles in the euro area diverged during 2020 and how atypical the current relationship between them has become.
This yawning gap has important implications for investors, especially those arguing for asset allocation shifts towards cyclical and value plays and shorter duration trades. The message from the money sector with elevated uncertainty, low confidence, weak consumption and subdued credit demand, remains a clear, “not so fast.”
Money sitting in overnight deposits drives neither GDP nor higher inflation.
The six charts that also matter
Broad money (M3) grew 12.3% YoY in December 2020, up from 11.0% in November, the fastest rate of growth since November 2007. In comparison, adjusted loans to the private sector grew by only 4.7% YoY, unchanged from November and the average growth recorded over the 2H20. The gap between the growth in money supply and private sector borrowing hit a record high of 7.6ppt (see key chart above).
Growth in broad money (%YoY) and contribution from narrow money (ppt) (Source: ECB; CMMP)
What is driving M3 growth? Narrow money (M1) grew 15.6% YoY, up from 14.5% in November, and contributed 10.7ppt to overall money growth (see chart above). Both the growth rate in M1 and its contribution were new, record highs. The private sector continued to increase holdings of the most liquid assets in 2020 despite earning negative real returns on those investments.
Monthly flows into household deposits since January 2019 – horizontal line indicates 2019 average flow (Source: ECB; CMMP)
Monthly deposit flows by households and corporates peaked in March-April 2020 but remain well in excess of average 2019 monthly flows. December’s monthly flow of household deposits (€53bn), for example, was 1.6x the average monthly flow recorded in 2019 (€33bn). In the 2H2020, the monthly flow of household deposits averaged €50bn. In other words, while HH uncertainty peaked in March-April 2020, it ended the year at a very elevated level (see chart above). Over the same period, the more volatile NFC deposit flows averaged €25bn, more than double the average flows recorded in 2019 (not shown here).
Counterparts of M3 – contribution in ppt (Source: ECB; CMMP )
From a counterparts perspective, credit to general government and to the private sector contributed 8.1ppt and 5.6ppt to money growth respectively (see chart above). For reference, the respective contributions to the 4.9% money growth in 2019 were 3.7ppt and -0.7ppt respectively. Note the important role played by credit to general government here.
Trends in growth rates (%YoY) for NFC credit, mortgages and consumer credit (Source: ECB; CMMP)
As before, relatively robust NFC credit (7.0%) and resilient mortgage demand (4.7%) offset weakness in consumer credit (-1.6%). Note that, EA households paid down consumer credit in three of the last four months on 2020 (see chart below).
Monthly consumer credit flows (LHS) and YoY growth rate (RHS) for the EA (Source: ECB; CMMP)
Conclusion
Money growth in 2020 reflected fiscal and monetary easing in response to weak private sector demand and rising savings (with added uncertainty regarding the extent to which rising savings are forces or precautionary). These trends are in direct contrast to the pre-GFC period when money expansion was driven primarily by strong, or excess, private sector credit.
A favourite chart – different drivers and implications of M3 growth (Source: ECB; CMMP)
At the start of 2021, some were arguing that rising money supply suggests higher inflation and supports asset allocation shifts towards cyclical and value plays and shorter duration trades. The message from the money sector with elevated uncertainty, low confidence, weak consumption and subdued credit demand, remains a clear, “not so fast.”
Please note that the summary comments above are extracts from more detailed analysis that is available separately. A more comprehensive treatment of the components and counterparts of M3 can also be found in “Don’t confuse the messages” posted in October last year.
FIRE- vs COCO-based lending – a cross-EA comparison
The key chart
The balance between FIRE- and COCO-based lending in the six largest EA banking markets (Source: ECB; CMMP)
The key message
In “Fuelling the Fire, Part II”, I stressed the importance of distinguishing between different forms of credit. I made the contrast between productive, “COCO-based” credit and less-productive, “FIRE-based” credit, highlighted the shift towards greater levels of FIRE-based lending in the euro area (EA), and noted the negative implications of this trend for leverage, growth, financial stability and income inequality in the EA.
In this short, follow-on post, I add details on how the balance between these forms of credit differs between the largest EA banking sectors (NL/BE vs ES/IT) and across the EA as a whole. For interest, I also note an adaptation of Hyman Minsky’s hypothesis that states that over the course of a long financial cycle, there will be a shift towards riskier and more speculative sectors and discuss its application to EA banking briefly.
FIRE-based versus COCO-based lending across the EA
The balance between FIRE-based and COCO-based lending varies across the EA. Among the six largest banking sectors that account for just under 90% of total EA credit, FIRE-based lending ranges from 64% of total credit in the Netherlands to 43% in Italy (see the key chart above). Across the 19 EA economies, the low end of this range extends down to 40% in Slovakia and Greece, and Ireland joins the Netherlands and Belgium with a relatively high share of FIRE-based lending (see chart below).
The wider picture across the 19 EA member states (Source: ECB; CMMP )
Interestingly, in the Netherlands and Belgium, the two large economies with the highest share of less-productive FIRE-based lending, the NFC debt ratios are both 159% of GDP, well above the BIS threshold level of 90%. In both cases, the NFC sectors are deleveraging with debt ratios falling from peaks of 179% of GDP in the Netherlands (1Q15) and 171% of GDP in Belgium (2Q16).
Trends in NFC debt ratios (%GDP) in the Netherlands and Belgium (Source: BIS; CMMP)
The HH dynamics are very different however, re-enforcing the message that the EA money sectors are far from a homogenous group! In the Netherlands, for example, the HH sector has also been deleveraging since the 3Q201 when the debt ratio hit 121%. In contrast, HH leverage is increasing in Belgium, with the debt ratio hitting a new high (albeit a relatively low one) of 65% in 2Q20.
Trends in HH debt ratios (% GDP) in the Netherlands and Belgium (Source: BIS; CMMP)
The high levels of HH and NFC debt in the Netherlands has stimulated much research. Dirk Bezemer at the University of Groningen, for example, has studied the impact of these trends and the extent to which the financial sector helps, hurts or hinders the wider economy. His research builds on Hyman Minksy’s theory and the idea that over the course of a long financial cycle, investors will shift towards riskier and more speculative investments.
The 2008 crisis demonstrated that the Netherlands behaved in line with Minsky’s insights. It proved very vulnerable indeed to financial shocks. The country also experienced a stagnation in economic growth which was unusually long in international comparison.
Dirk Bezemer, “Why Dutch debt tells us economic growth may be fragile” 2017
Bezemer argues that Minksy’s theory can be applied to data on credit trends with “Minsky’s shift” being reflected in the decline in bank credit to the real sector (COCO-based credit) and an increase in funds flowing towards property and financial asset markets (FIRE-based credit). There are many similarities between Bezemer’s arguments and the trends highlighted in CMMP analysis. Please contact me for details.
CAGR in credit versus CAGR in nominal GDP (rolling, three years) in France (Source: BIS; CMMP)
That said, there are always exceptions to the rule. In France, for example, FIRE-based and COCO-based lending are more balanced (52%:48%) with the later growing strongly despite the fact that the NFC debt ratio hit a new high of 167% of GDP in the 2Q20.(This is the highest NFC debt ratio in this sample.) Over the past three years, the CAGR in HH and NFC credit in France has exceeded the CAGR in GDP by 4.4ppt and 5.4ppt respectively (see chart above), highlighting the fact that banking risk comes in many, different forms…
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
What now for bank capital distributions? Absolute and relative performance of SX7E index YTD (Source: Macrobond; CMMP analysis)
The key message
The current 3Q20 results season is refocusing the attention of investors, banks and regulators on the “exceptional and temporary” restrictions imposed on bank capital distributions during the COVID-19 pandemic.
The gradual recovery in banks’ dividend payouts up to that point had been a rare positive in an otherwise negative investment outlook for the sector. Their suspension added to the list of on-going negatives including “low profitability, high costs, the lack of sustainable business models at certain banks and insufficient investment in new technologies,” (ECB, 2020) that help to explain why banks have been the worst performing sector YTD.
The exceptional status of these restrictions reflects the fact that they applied to all banks irrespective of whether pre-determined capital limits had been breached or not. Their temporary status was a recognition of the perceived and real risks associated with such a “one-size-fits-all policy.”
Looking forward, higher expected losses (ELs) and risk-weighted assets (RWAs) resulting from the economic downturn and increase in non-performing loans will lead to a deterioration in capital ratios. However, estimates by my colleagues at zeb consulting suggest that the average CET1 ratio of the largest 50 banks will remain on a sufficient level. More importantly, their analysis highlights significant differences among the sample banks. They find no statistically significant patterns regarding specific business models or country/regional exposure.
Further vigilance is required but the case for maintaining blanket restrictions on capital distributions has weakened. However, just because regulators should return to judging the merits of capital distributions on a case-by-case basis does not mean that they will. Sympathy towards banks and their shareholders remains subordinate to other priorities.
Six charts that matter
The current 3Q20 results season is refocusing the attention of investors, banks and regulators on the “exceptional and temporary” restrictions imposed on bank capital distributions during the COVID-19 pandemic.
And then they were gone – the recovery in bank dividends was a rare positive for EA banks (Source: Macrobond; CMMP analysis)
The gradual recovery in banks’ dividend payouts up to that point had been a rare positive in an otherwise negative investment outlook for the sector. Across advanced economies, banks’ dividend yields had recovered from the low levels that accompanied the rebuilding of capital after the GFC.
Euro area (EA) banks increased their shareholders’ yields via dividends but also tended to raise capital by issuing new shares. In contrast, the recovery in yields for US banks was more modest, as US banks have returned more cash through share buybacks instead. ECB analysis suggests that US and Nordic banks were the most generous in terms of shareholder remuneration recently, ahead of their UK, Swiss and EA peers (see graph below).
EA banks increased shareholder yields via dividends but also tended to issue new shares (Source: ECB; CMMP analysis)
Their suspension added to the list of on-going negatives including “low profitability, high costs, the lack of sustainable business models at certain banks and insufficient investment in new technologies,” (ECB, 2020) that help to explain why banks have been the worst performing sector YTD. In previous posts, I have (1) explained that the macro building blocks that are required for a sustained improvement in banks’ profitability and share price performance have been missing, (2) highlighted that weak pre-provision profitability left European banks poorly positioned to absorb the impact of the COVID-19 pandemic, and (3) questioned the conviction of previous sector rallies. Despite a 2% recovery over the past month, the SX7E index has fallen 42% YTD and underperformed the wider SXXE index by 34%.
Another miserable year for bank investors (Source: Macrobond; CMMP analysis)
The 60% underperformance of EA banks over the past five years supports a central theme in CMMP analysis. The true value in analysing developments in the financial sector lies less in considering investments in banks and more in the understanding the wider implications of the relationship between the banking sector and the wider economy for corporate strategy, investment decisions and asset allocation.
Why bother analysing banks/developments in the financial sector? (Source: Macrobond; CMMP analysis)
The exceptional status of these restrictions reflects the fact that they applied to all banks irrespective of whether pre-determined capital limits had been breached or not. It is important to note that the implementation of post-GFC standards had improved the capitalisation of global banks and that the introduction of capital buffers also helped them to withstand stressed situations such as the current pandemic. When these buffers are drawn down to pre-determined levels, Basel standards place automatic limits on dividends, share buybacks and bonus payments. However, given the scale of the potential losses that might arise from the pandemic, supervisors moved to halt dividends and buybacks even if pre-identified capital limits had not been breached.
In the case of EA banks, Yves Mersch, a member of the Executive Board of the ECB and Vice Chair of its Supervisory Board, explained last month that “while prudent capital planning is the order of the day, the current economic uncertainty means that banks are simply unable to forecast their medium-term capital needs accurately. Such an unorthodox move was therefore justified by our ultimate goal to counteract procyclical developments and support banks’ capacity to absorb losses during the crisis without compromising their ability to continue lending to the real economy.”
Their temporary status was a recognition of the perceived and real risks associated with such a “one-size-fits-all policy.” Mersch also acknowledged that, “under normal conditions, profitable and healthy banks should not be prevented from remunerating their shareholders. Restricting dividends can increase banks’ funding costs, have an impact on their access to capital markets and make them less competitive than their international peers.”
Expected losses to increase signficantly for Europe’s 50 largest banks (Source: zeb consulting)
Looking forward, higher expected losses (ELs) and risk-weighted assets (RWAs) resulting from the economic downturn and increase in non-performing loans will lead to a deterioration in capital ratios. Estimates from my colleagues at zeb consulting suggest that ELs could rise to between EUR 543-632bn in 2021 and EUR 611-833bn in 2022. Combined with a rise in RWAs, this would result in a drop in average CET1 ratios to between 11.4% and 12.3% in 2021 and 11.4% and 12.6% in 2022. In other words, the average CET1 ratio of the largest 50 banks in Europe is expected to remain sufficient despite higher ELs and RWAs.
Capital positions expected to remain sufficient (Source: zeb consulting)
Their analysis highlights significant differences among the sample banks. In several cases, banks are expected to consume their pre-Covid-19 capital cushions and will be forced to use the capital buffers release by regulators. In the “zeb base case”, eight of the top 50 European banks fall into this category. This number increases to 18 in their more “severe scenario”. However, none of the banks will end up with CET1 ratios below the reduced post-Covid-19 requirements.
More importantly in the context of the current debate, they find no statistically significant patterns regarding specific business models or country/regional exposure.
Conclusion
Further vigilance is required but the case for maintaining blanket restrictions on capital distributions has weakened. Yes, European banks remain dependent on government support for private and corporate customers and regulatory easing regarding capital ratios and banks, regulators and governments also need to continue to work together to prevent future credit or liquidity crunches. ECB representatives are also correct to highlight the real challenges faced by banks in forecasting medium-term capital needs accurately and the argument that they and the IMF put forward in terms of the benefits of flexibility is valid (eg, additional capital preserved could be distributed to shareholders should it prove unnecessary).
Nonetheless, the significant differences that exist between European banks and the lack of significant patterns at the business model, country or regional exposure levels suggests that the case for a blanket approach to restrictions of banks capital distributions is much weaker now that it was at the start of the pandemic. However, just because regulators should return to judging the merits of capital distributions on a case-by-case basis does not mean that they will. Sympathy towards banks and their shareholders is subordinated below other objectives and I conclude with the words of Andrea Enria, the Chair of the ECB’s Supervisory Board from a recent interview with Handlesblatt:
The ban on dividends is an exceptional measure. We do not intend to make it a regular supervisory tool. It was introduced when governments, the ECB and ECB Banking Supervision announced a major support package to deal with the fallout of the pandemic. The ECB has calculated that the full use of government guarantee schemes might reduce banks’ loan losses by between 15 to 20 per cent in the euro area. The package was intended to allow banks to grant loans to households and companies, not to compensate shareholders. The pandemic led to factory and school closures, and some of us were locked down for months. Why should dividends, of all things, be the only sacrosanct element in our societies?
Andrea Enria, Interview with Handlesblatt (12 October 2020)
Please note that the summary comments and charts above are abstracts from more detailed CMMP and zeb consulting analysis that is available separately.
