#europe – Page 4 – Chris Mallin Macro Perspectives

“Missing the point?”

Household behaviour at an inflection point

The key chart

**Monthly HH money flows as a multiple of pre-pandemic levels** (Source: BoE; ECB; CMMP)

The key message

The behaviour of UK and euro area households reached a potentially important inflexion point at the start of 4Q21. Household (HH) money flows moderated sharply in October 2021 while monthly flows of consumer credit hit new YTD highs.

Recall that HHs increased their money holdings significantly during the pandemic and built up (estimated) excess savings of £162bn in the UK and €285bn in the EA – a combination of forced and precautionary savings. This meant that the rise in broad money during the pandemic was a reflection of the deflationary forces of increased savings and delayed consumption.

The accumulation of money holdings peaked during 2Q20 and again in 4Q20 and the low point in terms of YoY declines in consumer credit demand was passed in February 2021. Monthly flows of consumer credit have been positive for the past six months and hit YTD highs in October 2021 in both regions. At the same time, the accumulation of money holdings has fallen back to 1.2x and 0.6x pre-pandemic levels in the UK and EA respectively.

Unfortunately, the recent rise in COVID-19 cases, the emergence of the omicron variant and renewed restrictions imposed by the UK and EA governments may result in these points being missed, or, worse still, the positive trends being reversed. That said, firmer economic foundations in both the UK and EA (and higher levels of vaccinations) suggest that both regions are in a stronger position to face renewed COVID challenges than they were a year ago.

Missing the point – the charts that matter

HH money flows

HHs in the UK and EA increased their money holdings significantly during the COVID-19 pandemic. Monthly flows peaked at 6x pre-pandemic levels in the UK in May 2020 (see chart above) and 2.4x pre-pandemic levels in the EA a month earlier (see chart below). At the start of 4Q21, they had moderated to 1.2x and 0.6x pre-pandemic levels in the UK and EA respectively. A key building block for a sustained economic recovery.

**Monthly HH deposit flows in the EA (EUR bn) and multiple (x) of 2019 average flow** (Source: ECB; CMMP)

Excess HH savings

In aggregate, and as a result, HHs have built up excess savings in the form of bank deposits of £162bn in the UK (see chart above) and €285bn in the EA (see chart below) since February 2020. These reflect a combination of forced savings (that may be released relatively quickly to support economic activity) and precautionary savings (that are unlikely to move straight into investment of consumption).

**Estimated build up of excess HH savings in the EA (EUR bn)** (Source: CMMP estimates)

As noted back in May (see “More bullish on UK consumption”) and confirmed by the ECB in August 2021 (see “Economic Bulletin, Issue 5”). The majority of these accumulated savings have accrued to HHs that already have sizeable savings, have higher incomes, and are older. Such HHs typically spend less from any extra savings they accumulate i.e. they have relatively low marginal propensities to consume. The release of these excess savings is likely to be only partial and gradual, therefore.

Impact on monetary aggregates

**M1 as a percentage of M3 in the UK and EA** (Source: BoE; ECB; CMMP)

HH behaviour had a marked impact on money supply dynamics during the pandemic with narrow money (M1) representing an ever-larger share of broad money (M3) in both the UK and EA (see chart above). As an example, overnight deposits contributed 6.8ppt to the total EA broad money growth of 7.6% in October 2021 alone (see chart below).

**Contribution of M1 (ppt) to growth rate in EA M3 (% YoY)** (Source: ECB; CMMP)

This matters because the expansion of broad money during the pandemic reflected the deflationary force of HHs increasing their savings and delaying consumption. Money sitting in overnight deposits contributes to neither growth nor inflation.

HH demand for consumer credit

**Growth rates in consumer credit in the UK and EA (% YoY)** (Source: BoE; ECB; CMMP)

Annual growth rates in consumer credit reached a low point in February 2021 in both the UK (-10% YoY) and the EA (-3% YoY). The rate of decline has narrowed subsequently to -1.0% in the UK in October. In the EA, annual growth rates turned positive two months later in April 2020 (see chart above).

**Monthly consumer credit flows in the UK (£ bn) and EA (EUR bn)** (Source: BoE; ECB; CMMP)

More importantly, monthly flows of consumer credit have been positive for the past six months and reached their highest levels YTD in both the UK (£0.7bn) and EA (€2.7bn) respectively (see chart above).

Conclusion

A moderation in monthly HH money flows and a recovery in demand for consumer credit represent important foundations for a sustained recovery in the UK and the EA. The rise in COVID-related risks comes at a very delicate and unfortunate time, therefore, for the recovery in both regions. It remains too early to say whether recent events will reverse these dynamics in a meaningful manner. The positive news is that firmer economic foundations in both the UK and EA suggest that both regions are in a stronger position to face these challenges than they were a year ago.

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

“Enough is enough”

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

The key chart

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

The key message

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

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

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

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

“Enough is enough”

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

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

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

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

The ECB’s analysis includes three key risk factors:

First, nominal house prices grew at 7.3% in 2Q21, the fastest rate of growth since 2005 (see key chart above)

Second, house price and lending dynamics have been much stronger in many countries with pre-existing vulnerabilities. For example, despite above average degrees of over-valuation pre-pandemic (ie, >4% estimated overvaluation), RRE prices grew at above-average rates (ie, >7% YoY) in Luxembourg, the Netherlands, Austria, Germany, and Belgium in the year to end 2Q21 (see chart above)

Third, there is evidence of a progressive deterioration in lending standards, as reflected in the increasing share of loans with high LTV ratios. The share of new loans with LTVs above 90% reached 52% in 2020 compared with only 32% in 2016 (see chart below)

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

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

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

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

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

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

“(Re-)fuelling challenges II”

Synchronised money cycles and messages from the UK and EA

The key chart

Broad money growth (% YoY) in UK and the euro area (Source: BoE, ECB; CMMP)

The key message

UK and euro area (EA) money cycles remain highly synchronised with the message from both region’s money sectors remaining one of “slowing momentum”.

At the start of 2021, I highlighted three key signals among these messages: are monthly HH deposit flows moderating; is consumer credit recovering; and are money and credit cycles re-synching with each other? The context here being that narrow money (M1) drove the expansion of broad money (M3) in both regions during the pandemic, reflecting the DEFLATIONARY forces of heightened uncertainty, increased (forced and precautionary) savings, reduced consumption and relatively subdued demand for credit.

While monthly flows of HH deposits are well below their respective peaks, they rose in both regions in August, notably in the UK where August’s flow was 2x pre-pandemic levels. Money sitting idly in overnight deposits contributes to neither growth nor inflation. Household uncertainly remains elevated and consumption muted (see also “Delaying the delayable”). Monthly consumer credit flows remain subdued in August and YoY growth rates were -2.4% in the UK and flat in the EA. Money and credit cycles remain out-of-synch with each other, presenting challenges to policy makers and investors alike and reminding us not to confuse current money cycles with previous versions. Furthermore, not only is private sector credit demand relatively subdued, it is also increasingly driven by FIRE-based lending (largely mortgages) rather than more productive COCO-based lending (largely NFC and consumer credit).

Economies and markets have benefitted from changing policy mixes that have been necessary and appropriate. Momentum in the key drivers of a sustained recovery is slowing, however, and further refuelling is required as we enter 4Q21.

Four charts that matter

**Monthly HH deposit flows as a multiple of average 2019 monthly flows** (Source: BoE; ECB; CMMP)

While monthly flows of HH deposits are well below their respective peaks, they rose in both regions in August, notably in the UK where August’s flow was 2x pre-pandemic levels (see chart above). Money sitting idly in overnight deposits contributes to neither growth nor inflation. Household uncertainly remains elevated and consumption muted.

**Annual growth in UK and EA consumer credit** (Source: BoE; ECB; CMMP)

Monthly consumer credit flows remain subdued in August and YoY growth rates were -2.4% in the UK and flat in the EA (see chart above).

**Lending growth minus money supply growth in the UK and EA** (Source: BoE; ECB; CMMP)

Money and credit cycles remain out-of-synch with each other (see chart above), presenting challenges to policy makers and investors alike and reminding us not to confuse current money cycles with previous versions.

**Growth rates in private sector credit by type** (Source: BoE; ECB; CMMP)

Furthermore, not only is private sector credit demand relatively subdued, it is also increasingly driven by FIRE-based lending (largely mortgages) rather than more productive COCO-based lending (largely NFC credit and consumer credit).

Conclusion

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

“Tough to get too excited”

Recovery and reflation trades require more substantial foundations

The key chart

**Growth in M3 (% YoY) and contributions (ppt) from M1 and PSC** (Source: ECB; CMMP)

The key message

It is tough to get too excited about the messages coming from the euro area’s (EA) money sector at the start of 3Q21.

Broad money growth is almost 5ppt lower than its January 2021 peak. The positive news here is that households are saving less, indicating that uncertainty levels have fallen. The less positive news is that growth in private sector credit has also fallen to its slowest rate since December 2017. Total lending is growing only 0.8% YoY in real terms and is falling -1.3% YoY in real terms if we exclude lending to HH (mainly mortgages).

In short, while the message from the money sector remains positive for (already overvalued) house prices in the euro area, the wider message is that both a sustained recovery and reflation trades require a more substantial foundation.

The six charts that matter

**Growth in EA broad money % YoY** (Source: ECB; CMMP)

It is tough to get too excited about the messages coming from the euro area (EA) money sector at the start of 3Q21. Growth in broad money (M3) slowed to 7.6% YoY in July 2021, almost 5ppt below the January 2021 recent high of 12.5% (see chart above). The positive news is that this reflects a reduction in the deflationary forces that drove M3 growth during the pandemic.

**YoY growth rates in M3 and M1 since 2001** (Source: ECB; CMMP)

Narrow money (M1) which contributed 7.7ppt to the total 7.6% YoY M3 growth has slowed from 16.5% in January 2021 to 11.0% in July 2021 (see chart above). In short, EA households are saving less.

**Monthly flows (EUR bn) of HH deposits during phases of pandemic** (Source: ECB; CMMP)

Overnight deposits still account for 6.8ppt of total M3 growth, but in aggregate household monthly deposit flows fell to €23bn in July 2021, below the 2019 average monthly flow of €33bn and the smallest monthly flow since June 2019 (see chart above).

**Growth in PSC (% YoY 3m MVA) since 2001** (Source: ECB; CMMP)

The less positive news is that credit demand is also slowing. Private sector credit contributed only 3.5ppt to M3 growth and the YoY growth rate slowed to 2.9% YoY (3MVA) the slowest growth since December 2017 (see chart above).

**Trends in growth in lending and contribution from lending x HH** (Source: ECB; CMMP)

As noted in “Strip out HH lending”, current lending is predominantly less-productive FIRE-based lending rather than productive COCO-based lending. Total lending grew 0.8% YoY in real terms in July, but fell -1.3% YoY in real terms excluding HH lending (see chart above). HH lending contributed 2.2ppt to the total 3.1% nominal growth in lending in July 2021 (see chart below).

**Drivers of PSC growth** (Source: ECB; CMMP)

Conclusion

In summary, while the message from the money sector remains positive for (already overvalued) house prices in the euro area, the wider message is that both a sustained recovery and reflation trades require a more substantial foundation.

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

“Strip out HH lending”

…and PSC growth is falling in real terms in the EA

The key chart

**Real YoY growth rates in total lending and total minus HH lending** (Source: ECB; CMMP)

The key message

Strip out lending to households (mainly mortgages) and private sector lending in the euro area (EA) is falling in real terms. Why does this matter?

A resynchronisation of money and credit cycles in the euro area is one of three key signals indicating a sustained economic recovery for investors and policy makers alike. The ideal scenario would see a reduction in the deflationary forces that drove M3 growth during the pandemic (i.e. HH money holdings) combined with a recovery in productive lending to the private sector. To date, we have witnessed progress in the former but not in the latter.

Monthly flows of HH deposits in April, May and June 2021 were below pre-pandemic levels, for example. Lending to the private sector is slowing too, however, from 4.7% at end 2020 to 3.0% at the end of 1H21. Base effects play a role here as EA corporates borrowed €243bn in the immediate “dash for cash” in March, April and May 2020. For context, net borrowing over the subsequent 12 months to June 2021 totalled only €103bn.

Significantly, total lending minus HH lending (predominantly productive COCO-based lending) contributed only 0.8ppt to the 3.0% YoY lending growth in June 2021. In contrast, HH lending contributed 2.1ppt, the bulk of which is in the form or mortgages.

In other words, current lending is essentially less-productive FIRE-based lending rather than productive COCO-based lending. While this may provide further support for house prices, a sustained recovery requires a more substantial foundation.

The six charts that matter

**Growth (% YoY) in broad money and private sector credit** (Source: ECB; CMMP)

A resynchronisation of money and credit cycles in the euro area is one of three key signals indicating a sustained economic recovery for investors and policy makers alike.

**What drove M3 growth during the pandemic?** (Source: ECB; CMMP)

The ideal scenario would see a reduction in the deflationary forces that drove M3 growth during the pandemic (i.e. HH money holdings) combined with a recovery in productive lending to the private sector. To date, we have witnessed progress in the former but not the latter.

**Monthly flows (EUR bn) in HH deposits** (Source: ECB; CMMP)

To date, we have the former but not the latter. Monthly flows of household deposits in April, May and June 2021 were below pre-pandemic levels. So far, so good.

**Nominal YoY growth rates in total lending and total minus HH lending** (Source: ECB; CMMP)

Lending to the private sector is slowing too, however, from 4.7% at end 2020 to 3.0% at the end of 1H21.

**Monthly flows in NFC borrowing in EUR bn** (Source ECB; CMMP)

Base effects play a part here as EA corporates borrowed €243bn in the immediate “dash for cash” in March, April and May 2020. For context, net borrowing over the subsequent 12 month to June 2021 totalled only €103bn.

**Drivers of PSC growth by type** (Source: ECB; CMMP)

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

“Bienvenido de nuevo”

Spain has re-joined the EA mortgage party

The key chart

**Monthly mortgage flows since January 2019** (Source: ECB; CMMP)

The key message

Monthly mortgage flows suggest that Spain is re-joining the “euro area mortgage party” but this presents mixed messages for investors.

Spain remains the euro area’s (EA) third largest mortgage market despite the fact that the outstanding stock of mortgages (€510bn) is 23% below its December 2010 peak (€665bn). Spain’s market share has fallen from 19% of EA mortgages in December 2008 to 11% in June 2021 and Spanish MFIs have recorded 120 consecutive months of negative contributions to EA mortgage growth since April 2011.

Monthly mortgage flows turned positive in February 2021, however. Annual growth rates turned positive in May 2021 and Spanish MFIs made a positive, albeit small, contribution to total EA growth in June 2021. I highlighted four factors that suggested a more positive demand-side outlook two months ago (see “More consistent than Rapha”). First, the HH debt ratio has fallen back in line with EA averages following a decade of deleveraging. Second, the cost of borrowing is at a record low. Third, the HH debt service ratio is below the LT average and close to its 20-year low. Finally, Spanish house prices are 28% below their peak in real terms with less extreme valuations than elsewhere in the EA.

The latest dynamics present mixed messages for investors. On the bright side, a sustained positive contribution to EA growth represents an important signal for investors positioned for a wider recovery in Europe. Germany and France have been the main drivers of mortgage growth in the recent past, but demand is now widening with Belgium, the Netherlands, Italy, Austria and Spain making larger collective contributions.

That said, these trends also reflect the broader substitution of productive COCO-based lending with less-productive FIRE-based lending in the euro area, which has negative implications for leverage, growth, financial stability and income inequality in the region. Spain has seen the largest shift in percentage points from COCO-based to FIRE-based lending since January 2009 but uniquely this reflects falls in the outstanding stock of both COCO-based (-€488bn) and FIRE-based lending (-€125bn) over the period.

The underlying message here is that mortgage dynamics in the periphery of the EA remain very different from those in the core re-enforcing the message that a “one-size-fits-all” policy response will not suffice.

“Bienvenido de nuevo” in charts

**Market share of EA total mortgages** (Source: ECB; CMMP)

**Outstanding stock of Spanish mortgages and market share** (Source: ECB; CMMP)

**Spanish MFIs contribution to EA mortgage growth** (Source: ECB; CMMP)

**Country drivers of EA mortgage growth** (Source: ECB; CMMP)

**Trends in balance between COCO-based and FIRE-based lending** (Source: ECB; CMMP)

**Spanish COCO-based lending** (Source: ECB; CMMP)

**Spanish FIRE-based lending** (Source: ECB; CMMP)

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

“FIRE, FIRE II”

The challenge for EA policy makers

The key chart

**Change in the stock of COCO-based lending Jan 2009 – June 2021 in EUR bn** (Source: ECB; CMMP)

The key message

Policy makers face significant challenges in addressing the implications of rising FIRE-based lending in the euro area.

My previous post highlighted the on-going substitution of productive COCO-based lending for less productive FIRE-based lending in the euro area (EA), noted the lack of COCO-based lending at the aggregate level since January 2009, and examined the implications for leverage, growth, financial stability and income inequality.

This post looks behind the aggregate headlines and focuses on three key differences at the country and regional level:

First, the share of FIRE-based lending among the EA’s six largest economies/banking markets at the end of 1H21 ranges widely from 65% in the Netherlands to 43% in Italy
Second, while the share of FIRE-based lending has increased in each economy, the drivers have been very different
Third, the lack of growth in COCO-based lending masks divergent trends between periphery economies (falling stock in Spain and Italy) and core economies (rising stock elsewhere)

Behind each of these differences lie significant variations in the level, structure and growth of debt across the euro area e.g. the Netherlands versus France, Belgium, Spain versus Germany and Italy.

In addressing the negative implications of rising FIRE-based lending in the EA, policy makers must address significant variations that exist at the regional and country level. A “one-size-fits-all” response will not suffice.

FIRE, FIRE II – three key differences, six key charts

Balance of lending – FIRE vs COCO

**FIRE-based versus COCO-based lending as at end 1H21 (Source: ECB; CMMP)**

The balance between FIRE-based and COCO-based lending varies widely across the EA. Among the six largest banking sectors that account for c.90% of total credit, FIRE-based lending ranges from 65% of total private sector credit in the Netherlands to 43% in Italy (see chart above). Across the 19 EA economies, the low end of this range extends down to 39% in Greece and 41% in Slovakia while Ireland (61%) joins the Netherland and Belgium with a relatively high share of FIRE-based lending.

In the Netherlands and Belgium, the two economies with the highest share of FIRE-based lending, the NFC debt ratios of 152% and 166% GDP respectively are well above the BIS threshold of 90%. In both cases, the NFC sectors have been deleveraging with debt ratios falling from peaks of 180% GDP in the Netherlands (1Q15) and 171% GDP in Belgium (2Q16). The HH sector dynamics are very different however, re-enforcing the message that the EA money sectors are far from a homogenous group (see below). In the Netherlands, the HH sector has also been deleveraging since 3Q10 when the debt ratio hit 121% GDP. At the end of 1H21, the ratio had fallen to 105% GDP. In contrast, HH leverage is increasing in Belgium with the debt ratio hitting a new high (albeit a relatively low one) of 66% GDP in 2Q21.

Drivers of change in lending balance

**Change in share of FIRE-based lending and share of total lending as at end 1H21** (Source: ECB; CMMP)

While the share of FIRE-based lending has increased in each economy since January 2009 (see chart above), the drivers have been very different (see chart below). Spain saw the largest change in percentage points (11ppt) as the fall in the outstanding stock of COCO-based loans (-€488bn) was greater than the fall in the stock of FIRE-based loans (-€125bn). Italy saw the second largest change (10ppt) driven by a fall in the stock of COCO-based loans (-€153bn) and a rise in the stock of FIRE-based loans (€125bn). In contrast, France’s 6ppt increase from 46% to 52% loans reflected the largest absolute increases in both FIRE-based (€715bn) and COCO-based lending (€715bn).

**Changes in COCO- and FIRE-based loans since January 2009 by country** (Source: ECB; CMMP)

Core versus periphery

**Core vs Periphery – change in COCO-based lending since January 2009** (Source: ECB; CMMP)

The lack of growth in COCO-based lending at the aggregate level masks divergent trends at the regional level between periphery economies (falling stock) and core economies (rising stock). The stock of COCO-based loans fell -€79bn in aggregate between January 2009 and June 2021 (NFC-€130bn, consumer credit +€51bn). In the core economies of Germany and France, the stock of COCO-based loans rose by €674bn (€241bn in Germany, €433bn in France). In the periphery economies of Spain and Italy, however, the stock fell by -€641bn (-€488bn in Spain, -€153bn in Italy).

**Core vs Periphery – change in FIRE-based lending since January 2009** (Source: ECB; CMMP)

Similarly, the stock of FIRE-based lending rose €1,349bn between January 2009 and June 2021. In Germany and France the stock of FIRE-based loans increased €1,224bn (€509bn in Germany, €715bn in France). In Spain and Italy there was no growth as the -€125bn decline in Spanish FIRE-based loans counterbalanced the €125bn increase in Italian FIRE-based loans.

Background debt dynamics

**NFC debt ratios (x-axis) versus HH debt ratios (y-axis) and BIS threshold levels** (Source: BIS; CMMP)

Behind each of these differences lies significant variations in the level, structure and growth of debt across the euro area that complicate required policy response further. The chart above plots the EA and the six largest markets in terms of NFC and HH debt ratios versus the maximum threshold limits identified by the BIS as the level above which debt becomes detrimental to future growth.

At the aggregate level, the EA is characterised by excess NFC debt ratios (115% GDP versus 90% GDP threshold level). The HH debt ratio of 63% GDP remains below the 85% GDP HH threshold level. The Netherlands is unique here in the sense that both NFC and HH debt ratios are above the respective thresholds. France, Belgium and Spain all have excess NFC debt ratios but very different NFC debt dynamics (rising rapidly in France and Belgium while falling in Spain). In contrast, Germany and Italy have neither excess HH nor excess NFC debt ratios.

Conclusion

The on-going substitution of productive COCO-based lending for less productive FIRE-based lending has negative implications for leverage, growth, financial stability and income inequality in the EA. A policy response is required. Aggregate trends mask significant differences at the country and regional level, however, which complicate policy choices. A “one-size-fits-all” response will not suffice.

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

“FIRE, FIRE!”

Why the shift towards FIRE-based lending matters

The key chart

**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.

“Euro area leads the UK”

Money cycles remain synchronised, but the EA is leading the transition to normality

The key chart

**Trends in UK and EA broad money aggregates** (Source: BoE; ECB, CMMP)

The key message

The UK and EA money cycles remain highly synchronised but the UK is lagging the EA in terms of the phased, steady return to normality.

Narrow money drove the expansion of broad money in both cases during the pandemic, reflecting the DEFLATIONARY forces of heightened uncertainty, increased savings, reduced consumption and relatively subdued demand for credit.

Among the key signals indicating a return to normality are (1) a moderation in household deposit flows, (2) a recovery in consumer credit, and (3) a resynching of money and credit cycles.

Monthly HH deposit flows/uncertainty levels have peaked in the UK and the EA, but while June 2021’s monthly flows in the EA were slightly below pre-pandemic levels, UK flows (£10bn) remained double the pre-pandemic average. According to CMMP estimates, excess HH savings in the UK have now reached over £150bn at the end of 1H21 (below official forecasts of £160bn).

Monthly consumer credit flows have turned positive in both the UK and the EA. However, while YoY growth rates turned positive in April in the EA they remain negative (-2.2%) in the UK.

The desynchronization of money and credit cycles during the pandemic has created challenges for policy makers and bankers alike. The growth in the supply of money exceeded the growth in private sector credit by record amounts during Phase 2 of the pandemic. The gap between them peaked at 11ppt in the UK (February 2021) and 8ppt in the EA (January 2021). At the end of the 2Q21, the gaps remained at 6.4ppt in the UK and 5.3ppt in the EA. Narrower than before but still very wide in a historic context.

In previous posts, I cautioned about confusing the messages from the money sector and suggested that reflation trades needed refuelling. As we enter 2H21, it remains important to understand the messages from the money sector correctly.

Falling growth rates in broad money reflect a moderation in deflationary forces primarily. Both the UK and EA are transitioning towards a steady recovery phase albeit at a different pace. The level of HH excess savings in the UK suggests a higher gearing towards a recover in HH consumption but, to date, the EA is leading the transition.

EA leads the UK – in charts

**Trends in monthly HH deposit flows since January 2019** (Source: BoE; ECB; CMMP)

Monthly HH deposit flows/uncertainty levels have peaked in the UK and the EA, but while June 2021’s monthly flows in the EA were slightly below pre-pandemic levels, UK flows (£10bn) remained double the pre-pandemic average of £5bn (see chart above). According to CMMP estimates, excess HH savings in the UK have now reached over £150bn at the end of 1H21 (below official forecasts of £160bn).

**Trends in monthly consumer credit flows** (Source: BoE; ECB; CMMP)

Monthly consumer credit flows have turned positive in both the UK and the EA (see chart above). However, while YoY growth rates turned positive in April in the EA they remain negative (-2.2%) in the UK (see chart below).

**YoY growth in consumer credit since 2016** (Source: BoE; ECB; CMMP)

**Growth in lending minus growth in money supply since 2011** (Source: BoE; ECB; CMMP)

Conclusion

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

“Through the phases”

A steady return to normality in the euro area?

The key chart

**Monthly HH deposit flows (“uncertainty proxy”) through COVID phases** (Source: ECB; CMMP)

The key message

The message from the money sector in 2Q21 is that the euro area (EA) has entered “Phase 3” of the COVID-19 crisis – a phase characterised (so far) by a steady return to normality

Household (HH) deposit flows fell from €176bn in 1Q21 to €82bn in 2Q21 as uncertainly levels peaked and the accumulation of liquid assets slowed below pre-pandemic levels. HH borrowing flows recovered from €57bn in 1Q21 to €77bn in 2Q21, above pre-pandemic levels. Mortgage flows remained the key driver, increasing from €60bn to €72bn over the same period. Consumer credit also recovered, however, from net repayments of -€4bn in 1Q21 to additional borrowing of €2bn in 2Q21.

In a reversal of recent trends, the gap between quarterly flows of HH deposits and borrowing narrowed sharply from €170bn in 1Q21 to €5bn in 2Q21. That said, overall money and credit cycles remain out-of-synch with each other but the extent of the de-synchronisation has narrowed from the January 2021 peak.

Earlier this year, I identified three key signals among the messages from the money sector to look for in 2021: a moderation in monthly HH deposit flows; a recovery in consumer credit; and a re-synching of money and credit cycles. At the end of 2Q21, the first two signals have turned positive and the third is “less-negative.” Normality is starting to return, albeit slowly.

A key lesson from Phase 2 of the pandemic was that the expansion in broad money (M3) was a reflection of DEFLATIONARY not inflationary forces – heighted uncertainty, increased liquidity preference, delayed consumption, subdued demand for credit etc. Little wonder then, that so-called “reflation trades” ran out of steam – put simply, the messages from the money sector were misunderstood.

As we move into 2H21, and if the same deflationary forces continue to moderate, attention may switch back to private sector credit demand. Will it remain subdued, recover or roll over and will money and credit cycles move back into synch with each other?