Tag: #QE

“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.

“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.