The impact of ECB policy on financing flows to the private sector
The key chart
Trends in cumulative monthly flows (12 months, EUR bn) of loans to the EA private sector (Source: ECB; CMMP)
The key message
Financing flows to the euro area (EA) private sector are slowing very sharply. This is unsurprising given the relatively rapid pass through of ECB policy to the cost of borrowing for EA corporates (NFCs) and, to a lesser extent, the cost of borrowing for EA households (HHs). Note that the composite cost of borrowing for NFCs has risen 2.96ppt in the twelve months since June 2022. This compares with a 2.12ppt increases over the whole 32 month, 2005-08 tightening period.
The risk here is that the ECB lacks a playbook for the most aggressive period of monetary tightening in its history. The rapid pace of adjustment in financing flows (see key chart above) suggests that the risk of policy errors are rising rapidly with negative, potential impacts on financing flows to the EA economy and to the region’s future growth prospects. Note again, that in aggregate, NFCs have already paid back loans in seven of the past nine months. The issue here is that the EA relies heavily on bank finance and the region needs more, not less, productive lending and investment.
The warning signs are clear. How will the “data dependent” ECB respond in September?
Flowing over a cliff edge
Trends in 12-month cumulative flows of credit to the private sector (EUR bn) (Source: ECB; CMMP)
Financing flows to the euro area (EA) private sector are slowing sharply. Cumulative monthly flows of credit to the private sector totalled €197bn in the 12 months to July 2023 down from €758bn in the 12 months to July 2022 (see chart above).
Changes in composite costs of borrowing (ppt) in months after start of policy tightening (Source: ECB; CMMP)
The slowdown in financing flows is unsurprising given the relatively rapid pass through of ECB policy tightening to the cost of borrowing (COB) for NFCs and, to a lesser extent, HHs (see chart above).
The composite COB for NFCs has risen 2.96ppt in the twelve months since June 2022. This compares with a 2.12ppt increases over the 32 month, 2005-08 tightening period. The composite COB for HHs has risen 1.73ppt in the twelve months since June 2022. Again, for context, this compares with a 1.79ppt increase over the longer 32 month, 2005-08 tightening period.
The risk here is that the ECB lacks a playbook for the most aggressive period of monetary tightening in its history.
Trends in monthly and cumulative 12m flows of lending to NFCs (EUR bn) (Source: ECB; CMMP)
In aggregate, NFCs have repaid loans in six of the past nine months (see chart above). Cumulative monthly flows have fallen from €390bn in the 12 months to October 2022 to only €85bn in the 12 months to July 2023.
Trends in monthly and cumulative 12m flows of lending to HHs (EUR bn) (Source: ECB; CMMP)
In aggregate, HHs have repaid loans in two of the past three months (in each case, mortgage loans). Cumulative monthly flows have fallen from €285bn in the 12 months to June 2022 to only €40bn in the 12 months to July 2023.
Trends in cumulative monthly flows of loans to HHs, mortgages and consumer credit (EUR bn) (Source: ECB; CMMP)
The rapid slowdown in monthly flows to HHs, reflects mortgage dynamics primarily (see chart above). The composite cost of mortgages has risen 1.73ppt since June 2022. Cumulative flows have fallen from €268bn in the 12 months to August 2021 to only €40bn in the 12 months to July 2023. Despite a 1.85ppt in the composite cost of consumer credit, monthly flows have remained relatively resilient. However, as described in early posts, the demand for consumer credit has lagged well below pre-pandemic levels.
Conclusion
In summary, the rapid pace of adjustment in financing flows described above suggests that the risk of policy errors are rising rapidly with negative, potential impacts on financing flows to the EA economy and to the region’s future growth prospects. The EA relies heavily on bank finance and the region needs more, not less, productive lending and investment.
The warning signs are clear. How will the “data dependent” ECB respond in September?
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
The impact of ECB policy seen through 12-month cumulative flows
The key chart
12-month cumulative financing flows (EUR bn) presented in stylised consolidated balance sheet format (Source: ECB; CMMP)
The key message
Monetary developments in the euro area (EA) highlight the elevated risks of ECB policy errors and their potential, negative impact on financing flows to the EA economy.
Headline YoY growth numbers for broad money and its key component (narrow money) and counterpart (private sector credit) highlight the speed at which EA money and credit cycles are rolling over.
Broad money (M3) fell -0.4% YoY, the first annual decline since May 2010. Narrow money (M1) fell -9.2% YoY, driven by a 10.5% YoY decline in overnight deposits. Growth in private sector credit slowed to 1.6% YoY, the slowest annual rate of growth since May 2016. The warning signs are there…
Within broad money, arbitrage continues in favour of the highest remunerated deposits – depositors are actively seeking higher returns – but this is insufficient to compensate for outflows from overnight deposits. The very slow/limited pass through from higher policy rates to the cost of overnight deposits has been one of the unique features of the current hiking cycle.
Financing flows to the private sector, largely in the form of loans, remain positive in absolute terms. They are slowing very sharply on a cumulative 12-month basis, however (see next post for details).
In short, cumulative financing flows to the EA economy were -€96bn in the 12-months to July 2023, compared with flows of €1,574bn, €1,014bn and €92bn in the 12-months to July 2020, July 2021 and July 2022 respectively.
The risks of significant policy errors are rising with negative implications for financing flows to the EA economy. How will the “data-dependent” ECB respond in September?
The impact of ECB policy on financing flows to the EA economy
Headline YoY growth numbers for broad money and its key component (narrow money) and counterpart (private sector credit) highlight the speed at which EA money and credit cycles are rolling over (see chart below).
Growth rates (% YoY) in M3, M1 and PS credit (Source: ECB; CMMP)
Broad money (M3) fell -0.4% YoY, the first annual decline since May 2010. The outstanding stock of money (€15,957bn) has fallen -1.6% from its September 2022 peak (€16,214bn). Narrow money, the key component of broad money, fell -9.2% YoY, driven by a 10.5% YoY decline in overnight deposits. Growth in private sector credit, the key counterpart to broad money, slowed to 1.6% YoY, its slowest annual rate of growth since May 2016.
Recall that monetary aggregates are derived from the consolidated balance sheet of MFIs. The key components are found on the liabilities side of the balance sheet – narrow money (M1) which comprises currency in circulation, other short-term deposits (M2-M1) and marketable instruments (M3-M2). Note that longer-term liabilities are not part of M3 as they are regarded more as portfolio instrument than as a means of carrying out transactions. The key chart above presents 12-month cumulative flows in the form of a stylised consolidated balance sheet.
Growth rates (% YoY) in M1 and M2-M1 (Source: ECB; CMMP)
Within broad money, arbitrage continues in favour of the highest remunerated deposits but this is insufficient to compensate for outflows from overnight deposits. The annual growth rate in other short-term deposits (M2-M1) was 24% YoY in June and July 2023, the highest rate of growth since the start of the EMU. In contrast, the -9.2% YoY decline in narrow money was the sharpest contraction since the start of EMU (see chart above).
Monthly flows (EUR bn) in EA monetary aggregates (Source: ECB; CMMP)
The EA banking system has seen eleven consecutive months of outflows in overnight deposits (see chart above). The outflow of narrow money totalled -€1,072bn (see key chart above), overshadowing the positive inflows of €852bn and €153bn into other short-term deposits (M2-M1) and marketable securities (M3-M2) and, outside broad money, the €262bn inflow into longer-term financial liabilities (mainly debt securities issued by banks).
Note that the very slow/limited pass through from higher policy rates to the cost of overnight deposits has been one of the unique features of the current hiking cycle.
Trend in 12-month cumulative monthly flows of loans to the private sector (Source: ECB; CMMP)
Financing flows to the private sector, largely in the form of loans, remain positive in absolute terms. They are slowing sharply on a cumulative 12-month basis, however (see chart above and next post for details).
12-month cumulative financing flows (EUR bn) presented in stylised consolidated balance sheet format (Source: ECB; CMMP)
In short, cumulative financing flows were -€96bn in the 12-months to July 2023, compared with flows of €1,576bn, €1,014bn and €92bn in the 12-months to July 2020, July 2021 and July 2022 respectively.
The risks of significant policy errors are rising. How will a data-dependent ECB respond in September?
Please note that the summary charts and comments above are abstracts from more detailed analysis that is available separately.
Trends in total EA mortgages (EUR bn, LHS) and annual growth (% YoY, RHS) (Source: ECB; CMMP)
The key message
The answer to the question, “Is there such a thing as the EA mortgage market?” seems obvious. Of course there is.
We know its size (€5,228bn), its structure (biased towards fixed rate lending) and its importance to banks (40% of total lending). We also know the current cost of borrowing (3.44%) and the speed with which higher policy rates have passed through to this cost (147bp so far). We can monitor the rate of growth in mortgages (3.0% YoY in nominal terms, -3.7% in real terms) and in monthly flows (slowing sharply).
Not so fast…!
The complication here is that these aggregate data points mask very important variations at the national level. These include:
Size (€5,288bn): five national markets dominate (“the big five”). Germany and France account for 56% of total EA mortgages alone and for 85% together with the Netherlands, Spain and Italy.
Structure of new mortgages (over 75% fixed-rate): varies from over 90% variable-rate in Finland, Lithuania, Estonia and Latvia to over 90% fixed-rate in Slovenia, Slovakia, France, Belgium and Ireland. Among the big five, relatively high exposures to fixed rate lending in France, Germany and the Netherlands, relatively low exposures in Italy and Spain.
Exposure to mortgage lending (40% of total lending): ranges from 50% in Malta and Slovakia to 25% or less in Luxembourg and Greece. Among the big five, above average exposures in the Netherlands, Germany and Spain, below average exposures in France, and more noticeably in Italy.
Cost of borrowing (3.44%, April 2023): ranges from 5.32%, 5.27% and 4.99% in Latvia, Lithuania and Estonia respectively to 2.24% and 2.61% in Malta and France respectively. Among the big five above average costs in all markets with the exception of France. Note that French banks have (1) relatively high exposure to fixed rate mortgages and, (2) unlike most other EA lenders, are constrained by the Banque de France on the amount they can charge borrowers.
Transmission mechanism of higher policy rates (147bp, so far): most rapid in Lithuania, Latvia, Estonia, Portugal, and in Italy and Spain among big five – all markets with above average exposure to variable-rate mortgages. Weakest in Malta, Ireland, Greece, and among the big five in France, Germany and the Netherlands. With the exception of Malta, these markets all have relatively high exposures to fixed-rate lending.
Growth (slowed to 3.0% YoY in April 2023, the slowest rate since May 2018): Skewed heavily towards German and French growth dynamics (1.1ppt and 1.0ppt of total 3.0% respectively). Large variations in nominal growth rates from 9.8% and 9.5% in Lithuania and Estonia respectively to -4.0% in Greece and -1.9% in Spain and Ireland. Among the big five, above average growth in France, Germany and the Netherlands, but below average growth in Italy and Spain. In real terms, mortgage growth peaked at 5.0% YoY in December 2020, eight months before the peak in nominal growth. It turned negative in February 2022 and has been negative ever since (-3.7% YoY, April 2023). Only Belgium and Malta are experiencing positive mortgage growth in real terms.
What does this mean?
The EA mortgage market is as an aggregation of heterogeneous, national markets that differ greatly in terms of size, structure, importance, cost, transmission mechanism and growth rates.
The challenge for bankers, investors and analysts alike is to understand these differences and their implications. The far greater challenge for the ECB is to incorporate them all in the design of a “one-size-fits-all” monetary policy. The context, in part, for this week’s ECB press conference on Thursday 15 June 2023.
Is there such a thing as the EA mortgage market?
Market size
Trends in the outstanding stock of EA mortgages (EUR bn) (Source: ECB; CMMP)
The outstanding stock of mortgages across the EA was €5,228bn at the end of April 2023 (see chart above).
Five national markets (the “big five”) dominate in terms of size and account for 85% of the outstanding stock collectively (see chart below) – Germany (€1,574bn, 30% share), France (€1,333bn, 26% share), the Netherlands (€555bn, 11% share), Spain (€505bn, 10% share) and Italy (€426bn, 8% share).
National mortgage markets ranked by size (EUR bn, LHS) and cumulative market share (%, RHS) (Source: ECB; CMMP)
Mortgage types
Twenty year trends in share of variable rate loans in total new mortages (%) (Source: ECB; CMMP)
At the aggregate level, just over three quarters of new mortgages are fixed-rate mortgages, up from 13% in March 2022 (see chart above). The structure varies, however, from over 90% variable rate mortgages in Finland, Lithuania, Estonia and Latvia to less than 10% variable rate mortgages in Slovenia, Slovakia, France, Belgium and Ireland (see chart below).
National mortgage markets ranked by exposure to variable rate lending (% new loans) (Source: ECB; CMMP)
Among the big five markets, the share of variable rate mortgages in new loans ranges from 41% and 39% in Italy and Spain to 20% in the Netherlands, 16% in Germany and only 4% in France. Note also that, in aggregate, the exposure to variable rate mortgages in the EA is currently higher than in the UK (18%).
Exposure to mortgage lending
National mortgage markets ranked by exposure to mortgages (% total loans) (Source: ECB; CMMP)
Mortgages account for 40% of total lending to EA residents at the aggregate level. This exposure ranges from 50% of total loans in Malta and Slovakia to 23% and 25% in Luxembourg and Greece respectively. Among the big five, banks in the Netherlands (48%), Germany (43%) and Spain (41%) have above average exposures to mortgage lending, while banks in France (39%) and, more noticeably, Italy (28%) have lower-than-average exposures.
Composite cost of borrowing for house purchase
National mortgage markets ranked by cost of borrowing for house purchase (%) (Source: ECB; CMMP)
In nominal terms, the CCOB for house purchases ranges from 5.32%, 5.27% and 4.99% in Latvia, Lithuania and Estonia respectively to 2.24% and 2.61% in Malta and France respectively (see chart above). Among the big five markets, the CCOB is above average in Italy (4.15%), Germany (3.89%), the Netherlands (3.62%) and Spain and only below average in France (2.61%).
Note that French banks have (1) relatively high exposure to fixed-rate mortgages and (2), unlike most other EA lenders, are constrained by a limit, set by the Banque de France, on the amount that they can charge for mortgages. In short, they have a lower sensitivity to the positive benefits of rising interest rates.
Note also that the CCOB of borrowing for house purchases remains below the current rates of inflation (HICP) in all of the EA economies except Luxembourg, Cyprus and Belgium.
Pass through of higher policy rates
National mortgage markets ranked by pass through (bp) of higher ECB policy rates (Source: ECB; CMMP)
The composite cost (CCOB) for new loans to EA HHs for house purchase has increased by 147bp since June 2022 to 3.44% in April 2023.
The pass through from policy tightening has been greatest (in nominal terms) in Lithuania (315bp), Latvia (284bp), Estonia (274bp) and Portugal (251bp) and in Italy (197bp) and Spain (179bp) among the big five markets.
The pass though has been weakest in Malta (11bp), Ireland (74bp), Greece (84bp) and in France (126bp), Germany (132bp) and the Netherlands (141bp) among the big five markets.
Change in CCOB since tightening (bp) plotted against current CCOB (% April 2023) (Source: ECB; CMMP)
Growth in mortgage lending
Trend in annual growth rate (% YoY, nominal) of lending to the private sector (Source: ECB; CMMP)
The annual growth rate in EA mortgages slowed to 3.0% YoY in April 2023, down 2.8ppt from the August 2021 peak of 5.8%. Growth has slowed 2.4ppt since tightening began in 2022. April 2023’s growth rate is the slowest rate of growth recorded since May 2018.
Contribution (ppt) of big five and “others” to growth in EA mortgages (% YoY) (Source: ECB, CMMP)
Germany and France have been the main contributors to aggregate growth since 2015. In April 2023, Germany and France contributed 1.1ppt and 1.0ppt to the total YoY growth of 3.0% alone. Netherlands and Italy contributed 0.4ppt and 0.2ppt respectively. The most obvious contrast between the post-2015 recovery in EA mortgage demand and the pre-GFC period is the lack of contribution/negative contribution from Spain for large parts of post-GFC period, reflecting the bursting of the Spanish real estate bubble.
National mortgage markets ranked by nominal growth rate (% YoY) (Source: ECB; CMMP)
Large variations exists in the nominal YoY growth rates at the country level. In April 2023, these ranged from 9.8% and 9.5% in Lithuania and Estonia respectively to -4.0% in Greece and -1.9% in both Spain and Ireland. Among the big five markets, growth was above average in France (4.1%), Germany (3.8%), and the Netherlands (3.6%) but below average in Italy (2.7%) and Spain (-1.9%).
Trends in mortgage growth rates expressed in nominal and real terms (Source: ECB; CMMP)
Inflation also complicates the analysis of EA mortgage dynamic. In real terms, mortgage growth peaked at 5.0% YoY in December 2020, eight months before the peak in nominal growth. It turned negative in February 2022 and has been negative since then. In April 2023, mortgage lending fell -3.7% YoY in real terms.
National mortgage markets ranked by real growth rate (% YoY) (Source: ECB; CMMP)
Conclusion
The EA mortgage market is as an aggregation of heterogeneous, national markets that differ greatly in terms of size, structure, importance, cost, transmission mechanism and growth rates. The challenge for bankers, investors and analysts alike is to understand these differences and their implications. The far greater challenge for the ECB is to incorporate them all in the design of a “one-size-fits-all” monetary policy. The context, in part, for this week’s ECB press conference on Thursday 15 June 2023.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Recent trends in monthly flows (EUR bn) and YoY growth rates in EA monetary aggregates (Source: ECB; CMMP)
The key message
If you wanted to “create panic” about euro area (EA) banks you could focus exclusively on negative YoY growth rates and monthly outflows in narrow money (M1), and then develop a narrative about money destruction and an impending credit crisis. After all, the EA is experiencing the fastest contraction in M1 since the creation of the Economic and Monetary Union in 1999, and banks have experienced eight consecutive months of negative flows in narrow money too.
Unfortunately, there are a number of problems associated with this “panic narrative”. It ignores simple concepts such as opportunity cost and portfolio rebalancing and mispresents the causal links in money creation.
The opportunity cost problem: unprecedented tightening by the ECB has led to a rapid increase in the opportunity cost of holding ON deposits, in contrast to most of the past decade. It has triggered a partial reallocation of ON deposits to other ST deposits. M2-M1 (other ST deposits) increased 21% YoY in April 2023 – also the fastest rate since the creation of the EMU.
The portfolio rebalancing problem: The phasing out of net asset purchases and TLTROs has incentivised the issuance of bank bonds (up €170bn) since September 2022. This has led to portfolio rebalancing away from deposits (down €200bn over the same period) to longer term liabilities that do not form part of monetary aggregates (by definition).
The causal link problem: the principal way in which bank deposits are created is through commercial banks making loans. Banks are not simply intermediaries that take in deposits and then lend them out (“loanable funds theory”). Instead, banks create money. Growth in private sector credit peaked in September 2022 (7.0% YoY) and has slowed to 3.3% in April 2023, however. This reflects the relatively rapid pass through from higher policy rates to the cost of borrowing, weaker loan demand and tighter credit standards. Slower credit growth implies slower deposit growth (ceteris paribus).
In short, recent EA monetary dynamics are unprecedented in some respects. They are not a cause for panic over EA banks, however. They reflect instead a combination of an increase in the opportunity cost of holding money, portfolio rebalancing, weaker credit demand and tighter credit standards.
This is not to suggest that the message from EA banks is a positive one. On the contrary, it remains one of weaker economic activity and a challenging policy context in which the ECB is expected to continue tightening as economic stresses mount.
An important message, but a very different one to the “bank panic narratives” seen elsewhere…
If you wanted to create panic about EA banks
Focus on narrow money
Growth rates (% YoY) in EA narrow money since 1999 (Source: ECB; CMMP)
Narrow money (M1) in the EA is contracting at the fastest rate since the creation of the Economic and Monetary Union (EMU) in 1999 (see chart above). The annual growth rate in M1 turned negative in January 2023 (-0.8%) and has decelerated each month since then: -2.7% YoY in February 2023; -4.2% YoY in March 2023 and -5.2% YoY in April 2023.
Monthly flows (EUR bn) in narrow money since June 2022 (Source: ECB; CMMP)
EA banks have also experienced eight consecutive monthly outflows of narrow money since September 2022, largely due to the outflow of overnight deposits. The outflow in April 2023 was €-75bn, compared with €-135bn in March 2023, and €-140bn in February 2023 (see chart above).
From here, it is tempting to create a “panic narrative” for EA banks. Tempting, but wrong…
Problems with the panic narrative – “opportunity cost”
Growth rate in M3 (% YoY) and contribution from ON deposits and other components (ppt) (Source: ECB; CMMP)
The first problem with the panic narrative is that it ignores the fundamental economic concept of opportunity cost.
Note that for most of the past decade, narrow money has been the main driver of EA broad money growth. The chart above illustrates the growth rate in broad money (M3) and the contributions to growth made by ON deposits (the light blue columns) and all other M3 components (the maroon columns).
The exceptionally large contribution and accumulation of ON deposits in the EA (and elsewhere) over the period reflects (1) the extended period of low interest rates and, more recently, (2) the COVID-19 pandemic. Unorthodox monetary policy reduced the opportunity cost of holding ON deposits dramatically and the pandemic resulted in a sharp rise in both forced and precautionary savings.
Policy tightening by the ECB since June 2022 has been notable for both its scale and pace. The pass through from higher policy rates to the cost of overnight deposits has been very slow/limited and has lagged the pass through to the cost of other forms of ST deposits, however.
In short, the opportunity cost of holding ON deposits has risen rapidly since the start of policy tightening.
Spread between rates on other HH ST deposits and HH ON deposits (ppt) (Source: ECB; CMMP)
The chart above illustrates the spread (or opportunity cost) between HH deposits redeemable at notice of up to three months and deposits with an agreed maturity of up to two years – the components of M2-M1 – versus HH ON deposits over the past 20 years.
The opportunity costs of holding notice deposits, and terms deposits with maturities of up to one year and between one and two years hit lows of 32bp, 13bp and 18bp in December 2021, June 2021 and March 2021 respectively. Since then they have risen to 106bp, 194bp and 194bp respectively, levels not seen since early 2013.
Spread between rates on other NFC ST deposits and NFC ON deposits (ppt) (Source: ECB; CMMP)
The chart above illustrates the spread (opportunity cost) between NFC time deposits – again M2-M1- and NFC ON deposits over the past twenty years. In this case the opportunity costs of holding term deposits hit lows of -33bp in November 2021 for maturities up to one year and 4bp for maturities between one and two years. Since, then they have risen to 215bp and 243bp respectively, levels last seen during the GFC.
Growth rates (% YoY) in M1 and M2-M1 since 1999 (Source: ECB; CMMP)
ECB policy has triggered a reallocation of funds from overnight deposits to other ST deposits. The growth rate in M2-M1 rose to 21% YoY in April. This is, in turn, the fastest rate of growth since the creation of the EMU.
Monthly flows (EUR bn) on EA monetary aggregates (Source: ECB; CMMP)
Inflows into other ST liabilities, M2-M1 and, to a lesser extent, M3-M2 have been important but still insufficient to compensate fully for the outflows in overnight deposits (see chart above). Hence, monthly flows of M3 have been negative in six of the past seven months.
Problems with the panic narrative – “portfolio rebalancing”
The second problem with the panic narrative is that it ignores portfolio rebalancing to other financial instruments. Note that money supply is derived from the banks’ ST liabilities and does not include longer-term liabilities since they are not close substitutes for money.
According to the ECB, bank bond issuance has increased by almost €170bn since September 2022. The terms and conditions of TLRTO II were recalibrated at this point resulting in sizeable repayments of funds borrowed under the programme and an increase in (more expensive) bond issuance. Bond issuance was close to total c€200bn decrease in the bank deposits over the period.
In short, M1 dynamics reflect both a substitution of ON deposits with time deposits (opportunity cost) and shifts to bank bonds (portfolio rebalancing) and, to a lesser extent money market fund shares. Funding costs may be rising but there is no evidence of liquidity-driven panic.
Problems with the panic narrative – “causal links in money creation”
The final problem with the panic narrative is that it misrepresents the causal links in money creation. Contrary to what is often taught (“loanable funds theory”), banks are not intermediaries that take in deposits first and then lend them out. Instead banks create money.
“Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money”
(Bank of England, 2014).
Growth rates in (adjusted) private sector credit (% YoY) since 2003 (Source: ECB; CMMP)
The principal way in which bank deposits are created is through commercial banks making loans. Growth in private sector lending peaked in September 2022 at 7% YoY, however (see graph above). In April 2023, growth has slowed to 3.3% YoY from 3.9% YoY in March 2023 and 4.3% YoY in February 2023. The moderation in bank lending reflects the relatively rapid pass through from policy rates to the cost of borrowing, weaker demand and tighter credit standards.
Growth rates in M3, M1 and private sector credit (% YoY) (Source: ECB; CMMP)
Conclusion – focus on the wider message not the panic narrative
In short, recent EA monetary dynamics are unprecedented in some areas. They are not a cause for panic over EA banks, however. They reflect instead a combination of an increase in the opportunity cost of holding money, portfolio rebalancing, weaker credit demand and tighter credit standards.
This is not to suggest that the message from EA banks is a positive one. On the contrary, it remains one of weaker economic activity and a challenging policy context in which the ECB is expected to continue tightening as economic stresses mount. An important message, but a very different one to the “bank panic narratives” seen elsewhere…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Quarterly consumer credit flows expressed as a multiple of pre-pandemic average flows (Source: ECB; FRED; BoE)
The key message
Does President Lagarde have an easier job than Chair Powell or Governor Bailey? In one important respect, yes.
Demand for consumer credit remains very subdued in the euro area (EA) in absolute terms and in contrast to trends observed in the US and the UK.
The European Central Bank (ECB), Federal Reserve and Bank of England each face delicate balancing acts between reducing inflation (their core mandates) and weaker growth. On the one hand, higher interest rates are supposed to deter borrowing and hence reduce aggregate demand and inflation. On the other hand, increased borrowing is one way that households can offset the pressures of falling real incomes.
“Higher interest rates provide incentives to households to save more now and postpone consumption from the present to the future”
Philip Lane, October 2022
In terms of reducing inflation, the fact that demand for consumer credit remains very subdued in absolute terms and in contrast to trends observed in the US and the UK makes President Lagarde’s task easier (if not easy!).
The EA has experienced eight consecutive quarters of positive consumer credit flows since 2Q21 (see key chart). These flows have yet to recover to their pre-pandemic levels, however. In 1Q23, the quarterly flow totalled €4.1bn, down from €5.2bn and €4.9bn in 4Q22 and 3Q22 respectively. Perhaps more importantly, the 1Q23 flow was only 0.4x the pre-pandemic average quarterly flow of €10.2bn.
Investors positioned for growth in the EA might take some comfort from the recovery in consumer demand in March 2023. The monthly flow rose to €2.6bn from €1.6bn in February 2023, but was still only 0.76x the pre-pandemic average flow of €3.4bn.
That said, the relatively subdued nature of EA consumer credit demand suggests that the risks to the ECB’s balancing act lie more towards weaker growth/recession. A different balance of risks to those faced by Chair Powell and Governor Bailey.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Three warning signs from the rolling over in EA money and credit cycles
The key chart
Trends in nominal YoY growth rates in M3, M1 and private sector credit (Source: ECB; CMMP)
The key message
As growth in euro area (EA) money supply in February 2023 falls to its slowest rate (2.9% YoY) since October 2014, the “message from the money sector” includes three key warning signs for the ECB and for investors in the region:
Warning sign #1: banks’ top-line growth. Banks continue to experience net outflows of ST liabilities and a substitution away from low-cost overnight deposits to more expensive “other ST deposits”, at the margin (this is not just a US story). At the same time, credit growth is slowing i.e. negative price and volume effects.
Warning sign #2: house prices and household consumption. Monthly flows of mortgage and consumer credit have slowed sharply, to well-below pre-pandemic levels.
Warning sign #3 (re-enforced): weakening economic growth outlook. Leading, coincident and lagging monetary variables are slowing sharply and in a coordinated fashion at a time when access to finance is becoming more difficult and more expensive.
On 16 March 2023, ECB President Lagarde commented that, “we are beginning to see the transmission of our monetary policy.” Eleven days later, the money sector is adding the important detail – increased stresses for banks, households and the economic outlook for the euro area.
Will the “data dependent” central bank listen to its money sector and, if so, how will it respond? The risks of policy mistakes are rising as quickly as money and credit cycles are falling…
Still tightening as stresses mount
Trends in broad money growth since 2003 (% YoY, nominal terms) (Source: ECB; CMMP)
According to the latest ECB “Monetary Developments in the euro area” data release (27 March 2023), growth in broad money (M3) fell to 2.9% YoY in February 2023, down from 3.5% in January 2023 and 4.1% in December 2022. February’s growth rate was the slowest since October 2014.
Trends in broad money growth (% YoY) and breakdown of contribution (ppt) (Source: ECB; CMMP)
The sharp slowdown in narrow money (M1) is a key driver here. Recall that at the point of the January 2021 peak in M3 growth (12.5%), M1 contributed 11.3ppt to this total growth in broad money (see chart above).
This reflected the fact that households (HHs) and corporates (NFCs) were hoarding cash, largely in the form or overnight deposits, despite the fact that they were only earning a return of 0.01%. In stark contrast, narrow money fell -2.7% YoY in February 2023 as overnight deposits fell -2.7% YoY.
As money supply growth slows sharply, the message from the money sector behind these headline figures contains three key warning signs for the ECB and for investors in the region.
Warning sign #1 – banks’ top line growth
Monthly flows of ST liabilities by type (EUR bn) (Source: ECB; CMMP)
Banks continue to experience net outflows of ST liabilities and a substitution away from low-cost overnight deposits to more expensive “other ST deposits”, at the margin. Continuing the theme from “Competing for funding”, EA banks have experienced outflows of ST liabilities in four of the past five months. This reflects six consecutive months of overnight deposits outflows (the blue columns in the chart above). Inflows in other ST deposits (within M2-M1 above) and, to a lesser extent, marketable securities (within M3-M2) have not been able to compensate. They also come at a higher cost.
Trends in private sector credit growth (% YoY) and breakdown of contribution (ppt) (Source: ECB; CMMP)
At the same time, credit growth is slowing. Adjusted private sector credit (PSC) growth peaked recently at 7.1% YoY in September 2022. NFC credit grew 8.9% at this point and made the largest contribution to total loan growth (3.5ppt). HH credit grew 4.4% and contributed 2.3ppt.
By February 2023, PSC growth had slowed to 4.3% YoY. NFC credit growth slowed to 5.7%, but remained the largest contributor to total PSC growth (2.2ppt). HH credit growth slowed to 3.2% YoY, a 1.7ppt contribution to total PSC growth.
Warning sign #2: house prices and household consumption
Trends in monthly mortgage flows (EUR bn) (Source: ECB; CMMP)
Monthly flows of mortgage and consumer credit have slowed sharply to below pre-pandemic levels.Monthly mortgage flows slowed to €5.1bn in February 2023, from €13.7bn a year ago (see chart above). Note that the growth in the outstanding stock of EA mortgages peaked at 5.8% in August 2021 and slowed noticeably after June 2022. February’s growth rate was 3.7% YoY, the slowest growth rate since November 2019.
Monthly consumer credit flows fell to €1.9bn in February 2023 from €3.4bn a year earlier (see chart above). Note that while consumer credit flows have recovered, they have remained below the average pre-pandemic flows of €3.4bn throughout the post-pandemic period. This is in contrast to trends observed in the US and the UK.
Monthly mortgage and consumer credit flows as a multiple of pre-pandemic average flows (Source: ECB; CMMP)
With monthly mortgage and consumer credit flows falling to 0.30x and 0.33x their respective pre-pandemic average monthly flows(see chart above), the EA money sector is sending clear warning signs for future house prices and HH consumption in the region.
Warning sign #3 (re-enforced): weakening economic growth outlook
Trends in real M1, HH credit and NFC credit (% YoY, real terms) (Source: ECB; CMMP)
Leading, coincident and lagging monetary variables are slowing sharply and in a coordinated fashion at a time when access to finance is becoming more difficult and more expensive. Real growth rates in M1, HH credit and NFC credit typically display leading, coincident and lagging relationships with real GDP. The sharp and coordinated slowdown in these variables has been sending warning signs from some months now. If historic relationships between these variables continue, this suggest that economic activity will decelerate over the next quarters.
Conclusion
On 16 March 2023, ECB President Lagarde commented that, “we are beginning to see the transmission of our monetary policy.” Eleven days later, the money sector is adding the important detail – increased stresses for banks, households and the economic outlook for the euro area.
Will the “data dependent” central bank listen to its money sector and, if so, how will it respond? The risks of policy mistakes are rising as sharply as money and credit cycles are falling…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Contrasting messages from the UK and EA money sectors
The key chart
Trends in monthly consumer credit flows expressed as a multiple of pre-pandemic averages (x) (Source: BoE; ECB; CMMP)
The key message
While the UK and euro area (EA) money sectors are sending consistent messages about the slowdown in mortgage demand, their messages about consumer credit demand are contrasting and diverging.
Monthly consumer credit flows recovered in the UK in January 2023, back to their pre-pandemic levels and to their highest level since June 2022. In contrast, they fell and remain depressed in relation to their pre-pandemic levels in the EA.
This matters for two reasons: (1) increased borrowing is one way that households can offset the pressures from falling real incomes and (2) consumer credit is the second most important element of productive COCO-based lending.
More policy challenges for the ECB…
Not so synchronised
UK consumer credit flows
The monthly flow of UK consumer credit increased to £1.6bn in January 2023, from £0.8bn in December 2022. This was the highest net borrowing since June 2022 and was 1.3x the pre-pandemic flow of £1.2bn. The 3m MVA of consumer credit flows increased to £1.2bn in January, from £1.0bn in December, very slightly above the pre-pandemic flow (see chart below).
Monthly flows of UK consumer credit (£bn) (Source: BoE; CMMP)
EA consumer credit flows
In contrast, the monthly flow of EA consumer credit fell to €0.3bn in January, down from €1.5bn in December and only 0.1x the pre-pandemic average flow of €3.4bn. The 3m MVA of consumer credit flows decreased to €1.3bn in January, from €1.7bn in December, 0.4x the pre-pandemic average flow.
Note that consumer credit flows in the EA have failed to recover to their pre-pandemic levels (see chart below).
Monthly flows of EA consumer credit (EUR bn) (Source: ECB; CMMP)
Why this matters
This matters since increased borrowing is one way that UK and EA HHs can offset the pressures from falling disposable incomes (along with reduced savings).
Consumer credit is also the second most important element of productive COCO-based lending, after corporate credit. It supports productive enterprise since it drives demand for goods and services, hence helping corporates to generate sales, profits and wages.
More policy challenges for the ECB…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Trends in the stock (EUR bn) and growth rate (% YoY) of EA mortgages (Source: ECB; CMMP)
The key message
The euro area (EA) money sector is sending a clear message at the start of 2023 – the ECB is succeeding in deflating the region’s mortgage market. Good news for financial stability, less positive for investors positioned for a recovery in EA growth.
Deflating the EA mortgage market
Trends in EA mortgage lending annual growth rate (% YoY) (Source: ECB; CMMP)
Annual growth in the outstanding stock of mortgages slowed to 3.9% in January 2023, down from 4.4% in December 2022 and the recent peak of 5.8% in August 2021 (see chart above). Monthly mortgage flows also slowed sharply to €2.8bn in January 2023, down from €25.7bn a year ago and their recent peak of €30.1bn in June 2022 (see chart below).
Mortgage dynamics in Germany and France are key drivers here. These markets account for 30% and 25% of the outstanding stock of mortgages and contribute 40% and 25% to total mortgage growth respectively (see chart below).
EA mortgage lending (% YoY) broken down by country (ppt) (Source: ECB; CMMP)
At the point of peak EA mortgage growth in August 2021, Germany mortgages grew 7.2% YoY and contributed 2.1ppt (36%) to total growth. At the same time, French mortgages grew 8.2% YoY and contributed 2.0ppt (34%) to total growth.
Trends in annual growth (% YoY) in EA, German and French mortgage lending (Source: ECB; CMMP)
Fast forward to January 2023, and German mortgage growth slowed to 5.2% YoY and contributed 1.5ppt (38%) to total growth. More importantly, French mortgage growth had slowed to 3.9% YoY and contributed only 1.0ppt (26%) to total growth. Note also that (more volatile) monthly flow data indicated net repayments in both Germany and France in January 2023.
Trends in annual growth in EA lending (LHS) and contribution from Germany and France (RHS) (Source: ECB; CMMP)
The trends summarised above are positive from a financial stability perspective. CMMP analysis highlighted RRE vulnerabilities in Germany based on the combination of house price and lending dynamics, the extent of overvaluation and the lack of appropriate macroprudential measures back in November 2021. It also warned of the risks associated with the rate of growth and affordability of French household sector debt in January 2022.
They are less positive for investors positioned for a recovery in EA growth, since mortgage demand typically displays a coincident relationship with GDP growth. Previous posts have noted a synchronised slowdown in mortgage demand in the EA and the UK, albeit with a more rapid deceleration in the former region. The Bank of England will publish UK mortgage data on 1 March 2023. More to follow then…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Atypical foundations for a bull market in European equities
The key chart
Trends in YoY growth rates in real M1, real HH credit and real NFC credit (Source: ECB; CMMP)
The key message
Monetary developments in the euro area (EA) present atypical foundations for a bull market in European equities.
The good news is that EA households have stopped hoarding cash and the region’s money and credit cycles have resynched with each other. Two (of three) key signals from the money sector suggesting a normalisation of economic activity.
The bad news is that the money and credit cycles are rolling over, credit demand is slowing in nominal terms, and growth rates in M1, HH credit and NFC credit are negative in real terms. This matters because these three variables (real M1, HH credit and NFC credit) typically display leading, co-incident and lagging relationships with real GDP over time. If historic relationships continue, this suggests a deceleration rather than an acceleration in economic activity over the next quarters.
The key question for asset allocators, therefore, is – do current monetary trends represent a form of positive, cold water therapy or simply a less-attractive cold shower?
Cold water therapy or cold shower?
Trends in broad (M3) and narrow (M1) money (% YoY, nominal terms) (Source: ECB; CMMP)
Monetary developments in the EA present atypical foundations for a bull market in European equities. Growth in broad money (M3) fell to 4.1% in December 2022, down from 4.8% in November 2022. This represents the slowest rate of growth since January 2019 (see chart above). Growth in narrow money (M1) slowed sharply to 0.6% in December 2022, down from 2.4% in November 2022. This represents the slowest rate of growth since August 2008. At the same time, the SXXE index closed at 449.17 on Friday 27 January 2023, up 26% from its early 4Q22 low.
Growth rate in M3 (% YoY) and contributions from ON deposits and other sources (ppt) (Source: ECB; CMMP)
The good news from the money sector is that EA households have stopped hoarding cash and the region’s money and credit cycles have resynched with each other. Recall that cash hoarding by HHs and NFCs in the form of overnight deposits was the key driver of the rapid expansion in broad money during the pandemic – a combination of forced and precautionary savings (see light blue columns in the chart above).
In the 4Q22, the flow of HH deposits fell to €26bn, the lowest quarterly flow since the pandemic began and well below the 2Q20 peak of €190bn and the pre-pandemic average flow of €91bn (see chart above). Recall also that a moderation in HH deposit flows was one of our three key signals for a normalisation of economic activity post-COVID. A second was a re-synching of money and credit cycles (see below).
Trends in M3 and PSC (% YoY) (Source: ECB; CMMP)
Money and credit cycles have been desynchronised for much of the past decade, creating major challenges for policy makers, banks and investors alike. The gap between the growth in money supply and the growth in private sector credit (PSC) hit a historic high during the COVID-pandemic (see chart above). As the region emerged from the pandemic, these growth rates have converged as the build-up in excess savings has slowed and the demand for credit has recovered (at least in nominal terms). A positive sign.
Trends in M3 and PSC (% YoY) since December 2017 (Source: ECB; CMMP)
The bad news is that the money and credit cycles are rolling over, credit demand is slowing in nominal terms, and growth rates in M1, HH credit and NFC credit are negative in real terms. Growth in adjusted PSC, for example, slowed to 5.3% in December 2022, down from 6.2% in November 2022 and down from the recent September 2022 peak of 7.0% (see chart above).
Trends in monthly mortgage flows (EUR bn) (Source: ECB; CMMP)
The monthly flow of mortgages, for example, fell to €4.5bn in December 2022, down from €8.9bn in November 2022 and down from the recent peak of €30.1bn in June 2022. The latest monthly flow was the lowest recorded since March 2020 (see chart above). The YoY growth rate in mortgages also fell to 4.4% in December 2020 down from 5.8% YoY in August 2021.
Monthly consumer credit flows also remain subdued in absolute terms and in relation to trends seen in the US and the UK. The monthly flow fell to €0.5bn in December 2022 from €2.1bn in November 2022 and €2.4bn in October 2022. As noted in “Clues from consumer credit”, the risks to EA economic growth lie more in the lack of demand for consumer credit and on-going household uncertainty.
Trends in real M1, HH credit and NFC credit (% YoY, real terms) (Source: ECB; CMMP)
Real growth rates in M1, HH credit and NFC credit typically display leading, coincident and lagging relationships with real GDP over time. Each indicator has peaked and is falling in real terms – -7.9% YoY, -4.9% YoY and -2.7% YoY respectively in December 2022 (see chart above). If historic relationships between these variables continue, this suggests a deceleration rather than an acceleration in economic activity over the next quarters.
In short, the key question for asset allocators is – do current monetary trends represent a form of positive, cold water therapy or simply 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 slow as EA demand shifts to more COCO-based borrowing
The Euro Area (EA) money sector is sending a clear message of a slowdown in the mortgage market at the start of 4Q22. Monthly mortgage flows have fallen for four consecutive months from a recent high of €30bn in July 2022 to €8bn in October 2022, the lowest monthly flow since April 2020 (€7bn) at the height of the COVID-19 pandemic (see chart above). The YoY growth rate has also slowed from its August 2021 peak of 5.8% to 4.8% in October 2022, the slowest YoY growth rate since February 2021 (4.5%).
The silver lining here is that the slowdown in mortgage demand is part of a recent structural shift away from less-productive FIRE-based lending (of which mortgages are the largest part) back towards more productive COCO-based lending (of which corporate lending is the largest part).
A year ago (October 2021), mortgages and corporate lending accounted for 2.2ppt and 0.8ppt to total private sector credit growth of 3.3% YoY respectively. Last month (October 2022), their respective contributions were 1.9ppt and 3.2ppt to a higher total credit growth of 6.2% (see chart below).
YoY growth rate in EA private sector credit and contributions of mortgage and corporate credit (Source: ECB; CMMP)
Please note that the summary comments and charts here are abstracts from more detailed analysis that is available separately.
