#europe – Page 5 – Chris Mallin Macro Perspectives

“We cannot waste the opportunity”

This is not the time to ignore Panetta’s warnings

The key chart

The key message

The EA may be leading the UK in a steady and synchronised recovery but this is not the time to repeat the post-GFC policy mistakes.

What are the euro area (EA) and UK money sectors telling us about the nature of the recovery from the COVID-19 pandemic?

The deflationary forces that drove the acceleration in broad money during the pandemic have peaked. Household (HH) uncertainly is falling, especially in the EA (key signal #1). Monthly flows in consumer credit were positive in May in both regions and the EA registered positive YoY growth in consumer credit for the second month running (key signal #2).The gap between lending growth and money growth is narrowing from recent record highs but both regions remain a long way from normalised money and credit cycles (key signal #3).

The 2Q21 message from the money sector is clear – the EA is leading the UK in a steady and synchronised recovery from the COVID-19 pandemic (so far), but with a challenging policy context looking forward. The comments from ECB Executive Board member, Fabio Panetta, that, “Combined fiscal and monetary support has lifted the economy out of the state of the emergency” appear well founded in this context.

The tentative nature of the recovery to date places even more importance on Panetta’s conclusion that, “We cannot waste the opportunity of having, for the first time in more than a decade, a combination of expansionary monetary and fiscal policies and a global reflationary environment to re-anchor inflation expectations to our target.”

This is not the time to repeat the post-GFC policy mistakes.

2Q21 messages from the money sectors

**M3 increasingly driven by M1 or narrow money** (Source: BoE; ECB; CMMP)

The deflationary forces that drove the acceleration in broad money during the pandemic have peaked. As can be seen in the chart above, narrow money (notes and coins in circulation and overnight deposits, or M1) represents an increasingly large proportion of broad money (M3) in both regions.

In May 2021, M1 accounted for 72% and 68% of M3 in the EA and UK respectively. This compares with 45% and 47% respectively in May 2009 and the GFC period. The key point here is that money sitting idly in overnight deposits contributes to neither growth nor inflation.

**Different drivers, different implications** (Source: ECB; CMMP)

As noted in previous posts (see “Don’t confuse the message”), it is important not to confuse the messages from the pre-GFC and COVID-19 periods of broad money expansion (see EA chart above). The message from the former period was one of over-confidence (low M1 contribution) and excess credit demand (high PSC contribution). In contrast, the recent message has been one of heightened uncertainty (high M1 contribution) and subdued credit demand (low PSC contribution). In short, recent money growth reflects fiscal and monetary easing in response to weak private sector demand and rising savings (with the added uncertainty regarding the extent to which rising savings are forced or precautionary).

Key signal #1 revisited

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

HH uncertainly is falling, especially in the EA (key signal #1). Monthly HH deposit flows are moderating in both regions. During the pandemic, HHs in both regions increased their money holdings despite earning negative returns – a combination of forced and precautionary savings. At their respective peaks, monthly flows were 2.4x (March 2020) and 6.0x (May 2020) their pre-Covid levels in the EA and UK respectively (see chart above).

In the EA, monthly flows were €31bn in May (up from €20bn in April) compared to the €33bn average flows seen during 2019. This was the second consecutive month when monthly flows were below their pre-COVID levels. In the UK, monthly flows were £7bn in May 2021, down from £9bn in April 2021, but still 1.5x their 2019 average of £5bn.

Key signal #2 revisited

**Trends in monthly consumer credit flows since January 2020** (Source: BoE; ECB; CMMP)

**YoY growth in consumer credit over past five years** (Source: BoE; ECB; CMMP)

Monthly flows in consumer credit were positive in May in both regions and the EA registered (slightly) positive YoY growth in consumer credit for the second month running (key signal #2).

HHs in the EA and UK borrowed €1.5bn and £0.3bn as consumer credit respectively in May 2021. This is the first time since August 2020 that UK consumers have borrowed more than they paid off. The Bank of England reported that this increase reflected £0.4bn in “other” forms of consumer credit such as card dealership finance and personal loans. In contrast, credit card lending remained weak with a net repayment of £0.1bn.

The EA has registered growth rates of 0.3% and 0.6% YoY in April and May 2021. In the UK, consumer credit fell -3.2% from -5.7% in April and the historic low of -10% in February 2021.

Key signal #3 revisited

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

The gap between lending growth and money growth is narrowing from recent record highs but both regions remain a long way from having normalised money and credit cycles (key signal #3).

Recall that in typical cycles, monetary aggregates and their key counterparts (eg credit to the private sector) move together. Money supply indicates how much money is available for use by the private sector. Private sector credit indicates how much the private sector is actually borrowing.

The gap has narrowed to 5.7ppt in the EA and 6.9ppt in the UK from recent, record highs of 8ppt (January 2021) and 11.4ppt (February 2021) respectively. This narrowing reflects a slowdown in both money supply and private sector credit, especially in the NFC sector.

Note that: (1) the effectiveness of monetary policy relies, in part, on certain stable relationships between monetary aggregates and their counterparts; and (2) that the desynchronization of money and credit cycles during the pandemic was unprecedented in both the EA and the UK.

**Trends in lending by type since May 2019** (Source: BoE; ECB; CMMP)

Conclusion

In this context, the comments from ECB Executive Board member, Fabio Panetta, that, “Combined fiscal and monetary support has lifted the economy out of the state of the emergency” appear well founded.

This is not the time to repeat the post-GFC policy mistakes.

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

“Consistent messages through atypical cycles”

Synchronised messages from the UK and EA money sectors

The key chart

**Don’t misread the messages from macro variables – this is an atypical cycle** (Source: BoE; ECB; CMMP)

The key message

It is important not to confuse the decline and recovery in economic activity over the past twelve months with typical economic cycles.

Headline growth figures in key macro variables, including monetary aggregates, have been open to misinterpretation, leading to many false narratives regarding their implications for investment decisions and asset allocation. In this context, CMMP analysis has gone beyond the headlines to identify three key signals that help to interpret current trends in the UK and EA effectively. These signals focus on HH behaviour, the consumption/growth outlook and the policy context.

The messages from the UK and EA money sectors are remarkably consistent in direction if not in magnitude.

Monthly HH deposit flows are moderating in both regions (key signal #1), especially in the EA, suggesting that uncertainty levels are falling. That said, HHs are still repaying down consumer credit (key signal #2), albeit at a slower pace (n.b. the YoY growth rate in consumer credit turned positive in the EA for the first time since last summer). Policy makers still face considerable challenges due to the on-going desynchronization of money and credit cycles, however (key signal #3). The resilience in mortgage demand and on-going house price rises bring additional challenges that complicate policy choices further.

Sustained recoveries require further moderations in HH deposit flows, a recovery in consumer credit, and a resynchronisation in money and credit cycles. The UK displays higher gearing than the EA to each of these key drivers but is lagging the EA in terms of positive signals so far…

Consistent messaging through atypical cycles

The UK and euro area (EA) money sectors have provided consistent messages regarding household (HH) behaviour, the consumption/growth outlook and the policy context in their respective regions throughout the COVID-19 pandemic.

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

Monthly HH deposit flows provide important insights into HH behaviour. During the pandemic, HHs in both regions increased their money holdings at elevated rates, despite earning negative returns. This behaviour contributed to neither growth nor inflation.

Deposit flows declined in both regions at the start of 2Q21 (see chart above). In the EA, monthly flows fell to €19bn in April 2021 from €62bn in March 2021. This is the first time since March 2020 that these flows have fallen below the €33bn average monthly flows seen during 2019. In the UK, monthly flows fell to £11bn in April 2021 from £16bn in March 2021, the smallest net flow since September 2020. While the direction of travel is the same in both regions, monthly money flows in the UK remain 2.3x above their 2019 average of £5bn.

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

While uncertainty is falling in both regions, consumption remains subdued. On a positive note, the YoY growth rate in consumer credit in the EA turned positive (0.3%) for the first time since August 2020 (see chart above). In contrast, growth remained negative in the UK (-5.7%) albeit less negative than the historic low of -10% recorded in February 2021.

That said HHs in both regions repaid consumer credit during April 2021 (see chart below). While this is not a positive signal for growth, the scale of repayments is slowing at least. In the UK, for example, net repayments of £0.4bn was less than seen on average each month over the previous year (£1.7bn).

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

The policy context remains challenging, however, especially for central bankers. The effectiveness of monetary policy relies, in part, on certain stable relationships between monetary aggregates. The desynchronization of money and credit cycles during the pandemic was unprecedented in both the UK and the EA.

**Trends in the gap between growth in lending and growth in money supply** (Source: BoE; ECB; CMMP)

The gap between YoY growth rates in private sector lending and money supply hit historic highs of 11ppt in the UK in February 2021 and 8ppt in the EA in January 2021. These gaps narrowed to 9ppt and 6ppt respectively in April. Nevertheless, they remain very wide in a historic context (see chart above).

Conclusion

To repeat, it is important not to confuse the decline and recovery in economic activity over the past twelve months with typical economic cycles.

The messages from the UK and EA money sectors are remarkable consistent in direction if not in magnitude. Monthly HH deposit flows are moderating (key signal #1), especially in the EA, suggesting that uncertainty levels are falling. That said, HHs are still repaying down consumer credit (key signal #2), albeit at a slower pace (and the YoY growth rate in consumer credit turned positive in the EA for the first time since last summer). Policy makers still face considerable challenges due to the on-going desynchronization of money and credit cycles, however. The resilience in mortgage demand and on-going house price rises bring additional challenges that complicate policy choices further.

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

“Has HH uncertainty peaked?”

An important first step in the road to euro area recovery

The key chart

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

The key message

The key message from the money sector at the start of 2Q21 is that the euro area (EA) has taken an important first step in the road to a sustained recovery.

**Trends in M3 growth (% YoY) and contributions (ppt) from M1 and private sector credit over the past twenty years** (Source: ECB; CMMP)

Recall that the rapid expansion in monetary aggregates during the COVID-19 pandemic was a reflection of DEFLATIONARY forces not inflationary ones, as some argue. Households (HHs) increased their money holdings (boosting M1 and M3) while simultaneously slowing consumption and repaying consumer credit. The key point here was that money sitting idly in overnight deposits contributed to neither growth nor inflation. This time, it really was different (see chart above)!

**Trends in monthly HH deposit flows since January 2021** (Source: ECB; CMMP)

At the start of 2Q21, monthly HH deposits flows fell to €19bn in April 2021 from €62bn in March 2021 (key signal #1).

This is the first time since March 2020 that these flows have fallen below the €33bn average monthly flows seen during 2019.

A sustained reduction in monthly deposit flows would indicate reduced uncertainty/improved confidence with positive implications for future consumption and economic growth.

**Trends in HH consumer credit since January 202**0 (Source: ECB; CMMP)

On a more cautious note, HHs repaid another €1bn of consumer credit (key signal #2) in April 2021, suggesting that the path to recover is still at a very early stage. The YoY growth rate in consumer credit turned positive (0.3%) for the first time since August 2020, but this was due to base effects and was despite the negative monthly flow (see chart above). HHs have repaid consmer credit in six of the past nine months.

**The widening gap between growth in lending and growth in money supply** (Source: ECB; CMMP)

Similarly, while the gap between money growth and credit growth (key signal #3) has narrowed from its recent historic high of 8ppt in January 2021 to 6ppt in April, it remains very high in a historic context (see chart above). Note that the YoY growth rate in adjusted loans to the private sector decreased to 3.2% in April 2021 from 3.6% in March 2021. Loans to NFCs fell from 5.3% to 3.2% while loans to HHs increased from 3.3% to 3.8% over the month (see chart below).

**Trends in mortgage, consumer credit and NFC lending since January 2019** (Source: ECB; CMMP)

In short, one of the three key signals for 2021 has turned positive, while the other two are “less negative.” Not time for Meatloaf to re-release an old hit yet, but welcome signs nonetheless since investment narratives require consistent refuelling.

In my next post, I will explore how and where investment risks may have shifted in the meantime.

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

“1Q21 update from the EA money sector”

Money growth peaked, but the message remains unchanged

The key chart

**What are the messages from the money sector as money growth peaks?** (Source: ECB; CMMP)

The key message

At the end of 1Q21, the cyclical and structural messages from the EA money sector remain unchanged. In terms of ST tactical trends and the outlook for 2021, we are looking for evidence of: (1) a moderation in HH deposit flows; (2) a resynchronisation of money and credit cycles; and (3) recovery in consumer credit. In terms of LT secular trends, we focus on the split between more productive COCO-based and less productive FIRE-based lending and the hidden risks of QE.

HH deposit flows remain almost double the levels seen pre-COVID and the enduring preference for holding highly liquid assets (despite their negative real returns) indicates persistently high levels of HH uncertainty. The gap between the money and credit cycles (evidenced in banks’ 1Q21 earnings) has stopped widening but remains very significant. Finally, consumer credit is still falling (and HHs repaid credit again in March) but at a slower rate than earlier in the quarter. In short, investors positioned for a sustained upturn in EA inflation will need to be patient still.

Resilient mortgage demand has been a key feature in an otherwise lacklustre retail banking sector (as in the UK). The 5.0% YoY increase in EA mortgages in March was the fastest rate of growth since May 2008. Mortgages are the largest segment of FIRE-based lending, which reached a new high of €5,891bn at the end of March, up 28% from its January 2009 level, and represented almost 52% of total lending. More productive COCO-based lending totalled €5,478bn, lower than its January 2009 peak of €5,517bn. COCO-based lending’s share of total lending has fallen from 55% to 48% of total lending over this period. The ECB is correct to highlight the positive impact of unorthodox monetary policy in terms of keeping borrowing affordable and supporting access to credit for NFCs and HHs. That said, the hidden risks of QE in “fuelling the fire” and their negative implications for leverage, growth, financial stability and income inequality in the EA should not be overlooked.

Money growth may have peaked, but the core messages from the money sector remain unchanged.

The core messages in six key charts

Key signals for 2021

**Persistent HH uncertainty reflected in monthy deposit flows** (Source: ECB; CMMP)

**The gap between the money and credit cycles has narrowed slightly, but remains significant** (Source: ECB; CMMP)

**HHs are repaying consumer credit but YoY declines are slowing** (Source: ECB; CMMP)

FIRE-based lending and the hidden risks of QE

**FIRE-based lending hits a new high at the end of 1Q21** (Source: ECB; CMMP)

**COCO-based lending is still lower than its 2009 peak** (Source: ECB; CMMP)

**By fuelling the fire, QE brings hidden risks that investors should not forget** (Source: ECB; CMMP)

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

“Patience, patience…”

Three key signals – January 2021 update

The key chart

**The biggest fail so far – money and credit cycles diverge even further in January 2021** (Source: BoE; ECB; CMMP)

Tke key message

Investors waiting in anxious anticipation for reflationary messages from the money sector will require some patience yet.

January 2020’s money supply data shows that households (HHs) in the UK and euro area (EA) continue to increase their holdings of liquid assets, money and credit cycles are diverging even further (to new highs), and consumer credit remains very weak. In other words, behind the headline figures, rising money supply in both regions remains a function of deflationary rather than inflationary forces – elevated HH uncertainty, relatively subdued demand for credit, and weak HH consumption. The drivers and implications of rapid money growth in the UK and the EA are very different from past cycles. Behind the headlines, and with three fails so far, the message from the UK and EA money sectors remains the same – “not so fast”.

Three key signals – January 2021

**Fail #1 – monthly flows in HH money holdings expressed as a multiple of 2019 average monthly flows** (Source: BoE; ECB; CMMP)

HHs in the UK and the EA continue to increase their holdings of highly liquid assets. In response to the COVID-19 pandemic, the levels of forced and precautionary savings have risen sharply. Today’s (1 March 2021) data release from the BoE, shows UK HHs increasing their money holdings by £18.5bn in January 2021, 4x the average monthly flows recorded in 2019. This is despite the fact that the effective interest rate paid on new time deposits remains at the lowest level (0.42%) since the series began. As noted, in my previous post, January’s monthly flows of HH deposits in the EA (€60bn) also remained almost 2x their 2019 average.

Money sitting idly in savings accounts contributes to neither GDP nor inflation.

**Fail #2 – the gap between the money and credit cycles have widened to new record levels** (Source: BoE; ECB; CMMP)

Rather than re-synching with each other, money and credit cycles in both regions widened to historic degrees in January 2021. The gap between the YoY growth in UK money (15.0%) and lending (4.4%) widened to a record 10.6ppt in January, while the gap between EA money (12.5%) and lending (4.4%) widened to 8.1ppt. Credit demand remains relatively subdued in both regions, despite the low cost of borrowing, while money supply has accelerated.

Fail #3 – growth rates (% YoY) of consumer credit in the UK and EA (Source: BoE; ECB; CMMP)

Consumer credit growth remains very weak. In the UK, HHs made net repayments of consumer credit of £2.4bn, the largest repayment since May 2020. The annual growth rate of -8.9% is yet another series low since the series began in 1994. Similarly, the -2.5% fall in consumer credit in the EA was the weakest level since February 2014.

Note that consumer credit represents one section of more productive COCO-based lending. It supports productive enterprise since it drives demand for goods and services, hence helping NFCs to generate sales, profits and wages. As before, with HHs hoarding cash and lockdown measure remaining in place, this weakness in consumer credit is not unexpected.

Conclusion

I have explained previously that the drivers and implications of rapid money supply growth in the UK and the EA are very different from past cycles and that the message from the money sectors in both regions for investors positioned for a sustained rise in inflation was, “not so fast.” The message from January’s data releases remains the same. Patience, patience…

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

“What if…”

…EA yield curves steepen but ST rates stay low?

The key chart

**10y-3m yield curves (7dMVA) in the US, Germany and France since 2018** (source: zeb; CMMP)

The key message

The gradual steepening of EA yield curves has led to renewed questions about the relative importance of the shape of the yield curve vis-à-vis the level of ST rates for the region’s banks (and their share price performance).

Banks’ NIMs have a positive relationship with both factors but, generally, the former is more important in countries and sectors exposed to higher fixed-rate lending and vice versa. Despite a shift away from floating-rate lending since 2009, just under 60% of all new loans to HHs and NFCs in the EA carry a floating rate. In other words, sensitivity to the level of ST rates remains high. As always, however, significant variations exist at the country, sector (and individual bank) levels. In France and the Netherlands, for example, only 36% of new loans carry a floating rate and only 15% of new mortgage loans for the entire EA carry a floating rate.

A scenario of steeper yield curves combined with delayed ST rate rises is broadly positive for the sector, and would favour fixed-rate countries (France, Netherlands, Belgium) and fixed-rate mortgage lending markets (France, Belgium, Germany, Netherlands, Italy, Ireland, Spain, Austria). This is very different from the (short-lived) period in early 2018 when expectations focused on higher ST rates combined with flatter yield curves. This favoured floating-rate economies (Finland, Portugal, Italy, Austria and Spain), NFC-lending sectors and floating-rate mortgage markets (Finland, Portugal) and led to brief outperformance from Italian, Spanish banks (and Erste Bank).

Investors’ expectations were dashed ultimately in 2018 and the case for a sustained steepening in EA yield cases remains unproven today (especially given M Lagarde’s comments on 22 February that the ECB was “closely monitoring” the market for government bonds).

On Thursday this week (25 February), the ECB will release its first review of monetary developments in the EA for 2021. As noted in my previous post, the key signals to look for then and in subsequent 2021 releases are: a moderation in monthly deposit flows; a resynching of money and credit cycles; and a recovery in consumer credit.

“What if?” – The charts that matter

**Trends in German and French 10y-3m yield curves (7d MVA) over past 6 months** (Source: zeb; CMMP)

Yield curves in the euro area’s (EA) two largest economies have steepened YTD (see chart above) albeit to a lesser extent than in the US (see key chart). This leads to the obvious question about the relative importance of the shape of the yield curve vis-à-vis the level of ST rates for the region’s banks (and their share price performance).

Yield curves versus ST rates – the background

Banks’ net interest margins (NIMs) have a positive relationship with both the shape of the yield curve and the level of ST rates. In short, this reflects two core functions of services that banks provide – a maturity transformation service (yield curve) and a deposit transaction service (ST rates). The relative importance of each factor depends largely on whether lending is predominantly fixed or floating-rate lending.

The slope of the yield curve is more relevant in countries or sectors with relatively high exposure to fixed-rate lending. In contrast, changes in ST rates have a greater impact on net interest margins in countries or sectors that are characterised by floating-rate lending. Furthermore, banks prefer a fixed rate when they expect reference rates to decline in the future and prefer a variable rate when they expect reference rates to increase. Borrowers have opposite preferences. In this regard, differences between loan characteristics provide an indication about the expectations of banks and borrowers with respect to the evolution of rates and their respective bargaining power. This in turn depends on factors such as banks’ funding conditions, competitive dynamics and borrowers’ levels of solvency.

(The impact of bank size is acknowledged here but is beyond the scope of this summary. However, it is worth noting that bank size may also have an impact on the sensitivity to both factors. This reflects the fact that larger banks are typically able to hedge their interest rate risk exposures better than smaller banks.)

Yield curves versus ST rates – the EA context

**Share of new loans to HH and NFC with a floating rate** (Source: ECB; CMMP)

Despite a shift away from floating-rate lending since 2009, 59% of all new loans to HHs and NFCs in the EA carry a floating rate (or an initial fixation period of up to one year). The peak level of floating rate lending in the past 15 years occurred after the GFC in January 2009 (84%). The lowest level occurred very recently in November 2020 (55%). As explained below, this trend affects both country and sector effects.

The key point here is that, while the sensitivity to the shape of the yield curve has increased, EA banks remain highly sensitive to the level of ST rates (at the aggregate level).

**Share of new loans to HH and NFC with a floating rate by country, December 2020** (Source: ECB; CMMP)

As always, however, significant variations exist at the country, sector (and individual bank) levels. The highest shares of floating-rate lending in new loans are currently found in Finland (93%), Portugal (78%), Italy (73%), Austria (68%), Spain (68%) and Ireland (66%). In contrast floating-rate lending in the Netherlands and France accounts for only 37% and 36% of total new loans respectively (see chart above).

**Share of new mortgage loans with a floating rate** (Source: ECB; CMMP)

While NFC lending remains largely floating-rate, only 15% of new mortages carry a floating rate (see chart above). Again significant differences exist here at the country level. The share of floating rate mortgages in total new mortgages ranges from highs of 98% and 67% in Finland and Portugal respectively to lows of 10%, 4% and 2% in Germany, Belgium and France respectively (see chart below).

**Share of new mortgage loans with a floating rate by country, December 2020** (Source: ECB; CMMP)

Yield curves versus ST rates – different scenarios

This is very different from the (short-lived) period in early 2018 when expectations focused on a scenario of higher ST rates combined with flatter yield curves. This favoured floating-rate economies (Finland, Portugal, Italy, Austria and Spain), NFC-lending sectors and floating-rate mortgage markets (Finland, Portugal) and led to ST outperformance from Italian, Spanish banks (and Erste Bank).

Conclusion

Investors’ expectations were dashed ultimately in 2018 and the case for a sustained steepening in EA yield cases remains unproven today, especially given M Lagarde’s comments on 22 February that the ECB was “closely monitoring” the market for government bonds. This was interpreted as a sign that the ECB might act to prevent rising yields undermining any economic recovery.

On Thursday this week (25 February), the ECB will release its first review of monetary developments in the EA for 2021. As noted in my previous post, the key signals to look for then and in subsequent releases are: a moderation in monthly deposit flows; a resynching of money and credit cycles; and a recovery in consumer credit (see, “Three key charts for 2021”)

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

“Three key charts for 2021”

And the trends that investors SHOULD be looking for…

The key chart

**Growth rates (% YoY) in UK and EA broad money aggregates** (Source: BoE; ECB; CMMP)

The key message

Should investors positioned for an upturn in inflation and sustained outperformance from cyclical and value plays and/or shorter duration trades be hoping for stronger or weaker money supply growth in the UK and EA in 2021?

Contrary to the popular narrative, the answer is likely to be the latter not the former. In this post, I summarise why this is the case and highlight the three key charts to follow in 2021.

Over the past decade, we have witnessed a sustained shift in the components of broad money supply (M3) with greater contribution coming from holdings of the most liquid assets ie, narrow money (M1). The reaction of UK and EA households to the COVID-19 pandemic has accelerated this trend, as levels of forced and precautionary savings have risen sharply, particularly in the UK.

The challenge for inflation hawks here is that money sitting idly in savings accounts contributes to neither GDP nor inflation.

Analysis of the counterparts of monetary aggregate highlights the extent to which money and credit cycles are diverging in both regions. Within subdued overall levels of private sector credit demand, relatively robust NFC credit and resilient mortgage demand offset weakness in consumer credit during 2020. Weakness in consumer credit was more noticeable in the UK, where net repayments of £17bn made 2020 the weakest year for consumer credit on record.

There are three key signals among the messages from the money sector in 2021 to look for:

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

Trends in 2020, suggest that the UK has a relatively high gearing to each of these trends.

The charts that mattered in 2020

**Share of narrow money in UK and EA broad money since 2010** (Source: ECB; BoE; CMMP)

Over the past decade, we have witnessed a sustained shift in the components of broad money supply (M3) with greater contribution coming from holdings of the most liquid assets ie, narrow money (M1). At the end of 2010, M1 accounted for 46% and 51% of M3 in the UK and EA respectively. By the end of 2020, these shares had risen to 67% and 71% respectively (see chart above).

In other words, changes in holdings of notes and coins and overnight deposits are having a greater impact on the behaviour of money supply. As noted in, “The yawning gap”, for example, M1 contributed 10.7ppt to the 12.3% growth in EA M3 in 2020.

**Monthly flows of HH money in the UK** (Source: BoE; CMMP)

The reaction of UK and EA households to the COVID-19 pandemic has accelerated this trend, as levels of forced and precautionary savings have risen sharply.

The first COVID-related death in the UK was recorded on 5 March 2020 and the first lockdown began 18 days later on the 23 March 2020. UK households increased their money holdings by £14bn, £17bn and £27bn in March, April and May 2020 respectively. This £58bn increase in holdings was greater than the total flow of £55bn recorded in 2019. Households began to increase then money holdings sharply again in October 2020, even though the second lockdown did not come into effect until 5 November 2020. In the last three months, UK households increases their money holdings by £13bn, £18bn and £21bn (£52bn in total), 3-4x the average monthly flows in 2019 (see chart above).

**Monthly flows of HH deposits in the EA** (Source: ECB; CMMP)

Similar household behaviour was seen in the euro area albeit with slightly different timings and scale. In the early stage of the pandemic, household deposits increased by €78bn and €75bn in March and April 2020 respectively, more than double the average 2019 monthly flows. In November and December 2020, monthly flows increased again to €61bn and €53bn (see chart above).

The challenge for inflation hawks here is that money sitting idly in savings accounts contributes to neither GDP nor inflation.

**Growth in private sector credit minus growth in money supply in the UK and EA** (Source: BoE; ECB; CMMP)

Analysis of the counterparts of monetary aggregate highlights the extent to which money and credit cycles are diverging in both regions. As noted last month, in typical cycles, monetary aggregates and their key counterparts move together. Money supply indicates how much money is available for use by the private sector. Private sector credit indicates how much the private sector is borrowing.

At the end of 2019, the gap between the growth in lending and the growth in money supply was 0.6ppt and -2ppt in the UK and EA respectively. By the end of 2020, these gaps had widened to record levels of -9.9pt and -7.6ppt (see chart above). Simply put, credit demand has remained relatively subdued in both regions, despite the low cost of borrowing, while money supply has accelerated.

**Trends in NFC credit, mortgages and consumer credit since 2018** (Source: BoE; ECB; CMMP)

Within subdued overall levels of private sector credit demand, relatively robust NFC credit and resilient mortgage demand offset weakness in consumer credit during 2020 in both regions (see chart above). The YoY growth in NFC credit in the UK increased from 3.3% in 2019 to 7.7% in 2020. Similarly, the respective growth rates in the EA increased from 3.2% in 2019 to 7.0% in 2020. Mortgage growth in the UK moderated slightly from 3.4% in 2019 to 3.0% in 2020 but rose from 3.9% in 2019 to 4.7% in 2020 in the EA. Consumer credit grew 6.1% and 6.0% in the UK and EA in 2019 respectively, but fell 7.5% and 1.6% in 2020 respectively.

**2020 monthly trends in HH consumer credit in the UK** (Source: BoE; CMMP)

**2020 monthly trends in HH consumer credit in the EA** (Source: ECB; CMMP)

The weakness in consumer credit was more significant in the UK than in the EA. Net repayments of £17bn made 2020 the weakest year for consumer credit on record. UK households repaid consumer credit in the last four months of 2020 and the annual growth rate of minus 7.5% represented the weakest rate of growth since the series began in 1994 (see first of the charts above). EA households also repaid consumer credit in three of the last four months of 2020, but the YoY decline of minus 1.6% was more moderate than in the UK.

Conclusion and three charts to watch in 2021

A sustained upturn in inflation and outperformance from cyclical and value sectors and shorter duration trades will require confidence, consumption and investment to return fully. There are three key signals to look for in the messages from the UK and EA money sectors in 2021.

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

First a moderation in monthly deposit flows, especially by the household sector, and slower growth in narrow money (M1) and hence broad money (M3).

**The yawing gap between money supply and private sector credit demand** (Source: BoE; ECB; CMMP)

Second, a re-synching of money and credit cycles with a corresponding rebalancing in the counterparts of broad money growth.

**Trends in YoY growth rates for UK and EA consumer credit** (Source: BoE; ECB; CMMP)

Third, and finally, a recovery in consumer credit. Consumer credit represents one section of COCO-based lending (see “Fuelling the FIRE”). Its supports productive enterprises since it drives demand for goods and services, hence helping NFCs to generate sales, profits and wages.

The relative scale in the shift of money holdings and weakness in consumer credit suggests that the UK has a higher gearing than the EA to a reversal of 2020’s COVID-19 induced dynamics. Watch this space in 2021…

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

“Fuelling the FIRE, Part IIb”

FIRE- vs COCO-based lending – a cross-EA comparison

The key chart

The balance between FIRE- and COCO-based lending in the six largest EA banking markets (Source: ECB; CMMP)

The key message

In “Fuelling the Fire, Part II”, I stressed the importance of distinguishing between different forms of credit. I made the contrast between productive, “COCO-based” credit and less-productive, “FIRE-based” credit, highlighted the shift towards greater levels of FIRE-based lending in the euro area (EA), and noted the negative implications of this trend for leverage, growth, financial stability and income inequality in the EA.

In this short, follow-on post, I add details on how the balance between these forms of credit differs between the largest EA banking sectors (NL/BE vs ES/IT) and across the EA as a whole. For interest, I also note an adaptation of Hyman Minsky’s hypothesis that states that over the course of a long financial cycle, there will be a shift towards riskier and more speculative sectors and discuss its application to EA banking briefly.

FIRE-based versus COCO-based lending across the EA

The balance between FIRE-based and COCO-based lending varies across the EA. Among the six largest banking sectors that account for just under 90% of total EA credit, FIRE-based lending ranges from 64% of total credit in the Netherlands to 43% in Italy (see the key chart above). Across the 19 EA economies, the low end of this range extends down to 40% in Slovakia and Greece, and Ireland joins the Netherlands and Belgium with a relatively high share of FIRE-based lending (see chart below).

**The wider picture across the 19 EA member states** (Source: ECB; CMMP )

Interestingly, in the Netherlands and Belgium, the two large economies with the highest share of less-productive FIRE-based lending, the NFC debt ratios are both 159% of GDP, well above the BIS threshold level of 90%. In both cases, the NFC sectors are deleveraging with debt ratios falling from peaks of 179% of GDP in the Netherlands (1Q15) and 171% of GDP in Belgium (2Q16).

**Trends in NFC debt ratios (%GDP) in the Netherlands and Belgium** (Source: BIS; CMMP)

The HH dynamics are very different however, re-enforcing the message that the EA money sectors are far from a homogenous group! In the Netherlands, for example, the HH sector has also been deleveraging since the 3Q201 when the debt ratio hit 121%. In contrast, HH leverage is increasing in Belgium, with the debt ratio hitting a new high (albeit a relatively low one) of 65% in 2Q20.

**Trends in HH debt ratios (% GDP) in the Netherlands and Belgium** (Source: BIS; CMMP)

The high levels of HH and NFC debt in the Netherlands has stimulated much research. Dirk Bezemer at the University of Groningen, for example, has studied the impact of these trends and the extent to which the financial sector helps, hurts or hinders the wider economy. His research builds on Hyman Minksy’s theory and the idea that over the course of a long financial cycle, investors will shift towards riskier and more speculative investments.

The 2008 crisis demonstrated that the Netherlands behaved in line with Minsky’s insights. It proved very vulnerable indeed to financial shocks. The country also experienced a stagnation in economic growth which was unusually long in international comparison.
Dirk Bezemer, “Why Dutch debt tells us economic growth may be fragile” 2017

Bezemer argues that Minksy’s theory can be applied to data on credit trends with “Minsky’s shift” being reflected in the decline in bank credit to the real sector (COCO-based credit) and an increase in funds flowing towards property and financial asset markets (FIRE-based credit). There are many similarities between Bezemer’s arguments and the trends highlighted in CMMP analysis. Please contact me for details.

CAGR in credit versus CAGR in nominal GDP (rolling, three years) in France (Source: BIS; CMMP)

That said, there are always exceptions to the rule. In France, for example, FIRE-based and COCO-based lending are more balanced (52%:48%) with the later growing strongly despite the fact that the NFC debt ratio hit a new high of 167% of GDP in the 2Q20.(This is the highest NFC debt ratio in this sample.) Over the past three years, the CAGR in HH and NFC credit in France has exceeded the CAGR in GDP by 4.4ppt and 5.4ppt respectively (see chart above), highlighting the fact that banking risk comes in many, different forms…

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

“Fuelling the Fire, Part II”

Addressing a major weakness in the current debate about debt

The key chart

**Trends in COCO- and FIRE-based lending (EUR bn, % total) since 2005** (Source: ECB; CMMP)

The key message

A major weakness in the current debate about debt in the “post-Covid world” is the failure to distinguish adequately between different forms of credit.

CMMP analysis, in contrast, draws a clear distinction between productive, “COCO-based” credit and less-productive, “FIRE-based” credit (see “Fuelling the FIRE, the hidden risk in QE”). This enabes a more accurate critique of current macro policy and a better understanding of the implications of unorthodox monetary policy (QE).

The shift towards greater levels of FIRE-based lending pre-dates the introduction of QE, but it was not until July 2016 that this form of credit exceeded COCO-based lending for the first time in the EA. The latest ECB data shows that FIRE-based lending now accounts for 52% of total lending (November 2020) reinforcing my September 2019 message that the “hidden risk in QE is that the ECB is ‘fuelling the fire’ with negative implications for leverage, growth, financial stability and income inequality in the EA.”

COCO- versus FIRE-based lending – the key concepts

In the broadest sense, lending can be spilt into two distinct types: lending to support productive enterprise; and lending to finance the sale and purchase of existing assets. The former includes lending to NFCs and HH consumer credit, referred collectively here as “COCO” credit (COrporate and COnsumer). The latter includes loans to non-bank financial institutions (NBFIs) and HH mortgage or real estate debt, referred to collectively as “FIRE” credit (FInancials and Real Estate). Dirk Bezemer (www.privatedebtproject.org) neatly distinguishes between the productivity of these different forms of lending:

COCO-based lending typically supports production and income formation
- CO: loans to NFCs are used to finance production which leads to sales revenues, wages paid, profits realised and economic expansion. Bezemer notes that these loans are used to realise future cash revenues from sales that land on the balance sheet of the borrower who can then repay the loan or safely roll it over. The key point here is that an increase in NFC debt will increase debt in the economy but it will also increase the income required to finance it
- CO: consumer debt also supports productive enterprises since it drives demand for goods and services, hence helping NFCs to generate sales, profits and wages. It differs from NFC debt to the extent that HH take on an additional liability since the debt does not generate income. Hence the consumer debt is also positive but has a slightly higher risk to stability

**Trends in outstanding stock of COCO-based loans since 2005** (Source: ECB; CMMP)

FIRE-based lending typically supports capital gains through higher asset prices
- FI: loans to NBFIs (eg, pension funds, insurance companies) are used primarily to finance transactions in financial assets rather than to produce, sell or buy “real” output. This credit may lead to an increase in the price of financial assets but does not lead (directly) to income generated in the real economy
- RE: mortgage or real estate lending is used to finance transactions in pre-existing assets rather than transactions in goods and services. Such lending typically generates asset gains as opposed to income (at least directly)

**Trends in outstanding stock of FIRE-based loans since 2005** (Source: ECB;CMMP)

Lending in any economy will involve a balance between these different forms, but the key point is that a shift from COCO-based lending to FIRE-based lending reflects different borrower motivations and different levels of risks to financial stability.

COCO- versus FIRE-based lending – the evidence from the euro area

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

At the end of November 2020, COCO-based lending in the EA totalled EUR 5,437bn. This is below the peak level of EUR 5,517bn recorded in January 2009. FIRE-based lending, in contrast, totalled EUR 5,792bn, 26% higher than the outstanding stock as at the end of January 2009. As can be seen in the chart above, FIRE-based lending exceeded COCO-based lending for the first time in July 2016. The current split of total loans is now 52% FIRE-based and 48% COCO-based, compared with respective shares of 45% and 55% in January 2009.

**NFC lending as a percentage of GDP since 2005** (Source: BIS; CMMP)

In other words, the shift towards increased FIRE-based lending pre-dates the introduction of QE in the EA. The shift becomes more noticeable in the post-GFC period and may also reflect the fact that NFC debt levels (expressed as a percentage of GDP) had exceeded the threshold level that the BIS considers detrimental to future growth for most of this period (see chart above).

COCO- versus FIRE-based lending – the impact of QE

Nevertheless, as noted back in September 2019, the hidden risk in QE is that the ECB is “Fuelling the FIRE” with potentially negative implications for leverage, growth, financial stability and income inequality in the Euro Area.

As noted above, while COCO-based lending increases absolute debt levels, is 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 whole. Hence, it is likely to result in high levels of leverage.

Similarly, COCO-based lending supports economic growth both by increasing the value-add from final goods and services (“output”) and an increase in profits and wages (“income”). In contrast, FIRE-based lending typically only affects GDP growth indirectly.

From a stability perspective, the returns from FIRE-based lending (investment returns, commercial and HH property prices etc) are typically more volatile that returns from COCO-based lending and may affect the solvency of lenders and borrowers.

Finally, the return from FIRE-based lending are typically concentrated in higher-income segments of the populations, with any subsequent wealth-effects increasing income inequality.

Please note that the summary comments above are abstracts from more detailed analysis that is available separately

“Out-of-synch”

What are the implications of the widening divergence between money and credit cycles?

The key chart

**The widening gap between growth in lending and growth in money supply** (Source: ECB; Bank of England; CMMP analysis)

The key message

Current money cycles in the EA and UK, (1) differ from previous cycles in terms of their drivers and implications, (2) are out-of-synch with the respective credit cycles, and (3) diverging from credit cycles at historically rapid rates. The implications here for growth, inflation, policy choices, investment returns and asset allocation are missing from many recent “2021 Investment Outlooks”.

Is it wise to ignore the “messages from the money sector”?

This week’s data releases show broad money growing at the fastest rate in the current money cycle in both the EA (11.0%) and the UK (13.9%). What is this telling us?

For some, rising money supply suggests higher inflation in the EA and the UK and supports asset allocation shifts towards cyclical and value plays and shorter duration trades. The message from the money sector with elevated uncertainty, low confidence, weak consumption and subdued credit demand is, “not so fast.”

The charts that matter

**Growth trends in EA and UK broad money aggregates in % YoY** (Source: ECB; Bank of England; CMMP analysis)

This week’s ECB and Bank of England data releases show broad money growing at the fastest rate in the current money cycle in both the EA and the UK (see chart above). M3 in the EA grew 11.0% YoY in November 2020, up from 10.5% in October. M4ex in the UK grew 13.9% YoY in November 2020, up from 13.2%.

To understand what these trends are telling us, and to understand how the current money cycle differs from previous cycles, we need to examine both the components and counterparts to broad money rather than focus simply on the headline numbers.

**Growth in M3 (% YoY) and contribution of M1 (ppt) to total growth** (Source: ECB; CMMP analysis)

From a components perspective, we can see that growth in narrow money i.e. notes and coins in circulation and, more importantly, overnight deposits is the key driver of overall money growth (see chart above). In the EA, for example, M1 grew at 14.5% YoY and contributed 9.9ppt to the 11.0% YoY growth in M3. Overnight deposits grew 15.0% YoY and contributed 8.9ppt to the total growth alone.

**Share of narrow money (M1) in broad money (M3) since 2000** (Source: ECB; Bank of England; CMMP analysis)

Recent trends are an extension/acceleration of longer-term secular shifts in the composition of EA and UK money supply (see chart above). Twenty years ago, M1 accounted for 42% and 48% of M3 in the EA and UK respectively. The shares were the same at the height of the GFC in 2008. Today, however, M1 accounts for 71% and 68% of M3 in the EA and the UK respectively. This increase in liquidity preference/money holdings reflects an increasingly lower opportunity cost of holding money as rates have fallen and, more recently, a sharp rise in both forced and precautionary savings by the regions’ households.

**Trends in monthly HH deposit flows 2019-2020 YTD** (Source: ECB; CMMP analysis)

Households are increasing their money holdings at 2-4x the average 2019 monthly rate, delaying consumption and repaying existing consumer credit with negative implications for economic growth and inflation. In the EA, household money holdings increased by EUR61bn in November, almost double the average flow of EUR33bn recorded during 2019 (see chart above). This reflects similar, albeit more volatile, trends in the UK highlighted in, “And now, the not-so-good-news” and to repeat the message in that post – money sitting in savings accounts does not contribute to GDP or higher inflation.

**Trends in monthly consumer credit flows and YoY growth rate** (Source: ECB; Bank of England)

EA households are not only delaying consumption, they are also repaying existing consumer credit. In November 2020, net repayments totalled EUR4bn, the largest amount since the peak of the first wave of the pandemic in April. On a YoY basis, consumer credit declined by 1.1%, the weakest level in the current slowdown (see chart above). In the UK, households repaid consumer credit for three consecutive months between September and November 2020 and YoY declines are the weakest since records began.

**Repeating the key chart – the widening gap between growth in lending and growth in money supply** *(Source: ECB; Bank of England; CMMP analysis)*

In terms of policy choices, monetary policy effectiveness requires stable relationships between monetary aggregates, but these are increasingly absent. The gap between growth rates in money supply and private sector credit demand is at record highs in both regions. In the EA, the gap between the supply of money (11.0%) and private sector demand for credit (4.7%) was 6.3ppt. In the UK, money supply grew 13.9%, 9.4ppt faster than private sector credit demand. This is one more reason to add to a lengthening list of why the required and sustained policy response should be, “fiscal, first and foremost.” In my next post, I will up-date my analysis to add another factor to this list i.e. credit is increasingly shifting towards less productive sectors of the economy (see also “Fuelling the FIRE – the hidden risk in QE“).

**A preview of the theme in my next post – COCO-based versus FIRE-based lending** (Source: ECB; CMMP analysis)

Conclusion

**What does this all mean?** (Source: ECB; Bank of England; CMMP analysis)

For some, rising money supply suggest higher inflation in the EA and the UK, and supports asset allocation shifts towards cyclical and value plays and shorter duration trades. The message from the money sector remains, “not so fast.”

**One of my favourite current charts! Growth in M3 and contribution of M1 and PSC.** (Source: ECB; CMMP analysis)

CMMP analysis of the components and counterparts of broad money tell a very different story from previous money cycles. The EA and UK money sectors are consistent signalling elevated uncertainty, low confidence, weak consumption and subdued credit demand – even before the introduction of further, more stringent lock-down policies in January 2021.

If there is a positive interpretation of current trends, it is that there is a large element of forced savings and hence pent-up consumer demand. That is true, but history also tells us that households and corporates can take time to adjust to major economic shocks and caution us against expecting a rapid reversal in confidence and consumption.

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