#strategy – Page 10 – Chris Mallin Macro Perspectives

“Rolling over?”

What does the slowdown in UK monetary aggregates mean?

The key chart

**Growth (% YoY) in money (M4ex) and lending (M4Lex) over past decade** (Source: BoE; CMMP)

The key message

Financial markets are typically sensitive to inflexion points and UK monetary aggregates are “rolling over”. Among the mixed messages, there is the overriding sense of slowing momentum with obvious risks to a sustained recovery and reflation trades.

The expansion in broad money during the pandemic reflected deflationary forces as uncertain households increased their money holdings and delayed consumption. Monthly money flows are moderating now (positive news) but remain elevated in relation to pre-pandemic levels and in relation to euro area dynamics. Growth in consumer credit remains weak in absolute terms (with the exception of niche areas such as the used-car market) again in contrast to EA dynamics. The gap between money growth and credit demand has narrowed from recent highs but remains significant, presenting on-going challenges to policy makers in both regions. The real surprise in July’s UK money supply data, however, was the £1.4bn repayment of mortgage debt, compounded by a slowdown in mortgage approvals.

The overriding message from the rolling over of UK monetary aggregates is one of slowing momentum. So-called “faster indicators” are sending the same message for August too. Uncertainty may be lower than during the height of the pandemic, but any recovery is gradual at best. Sustained recoveries and reflation trades in both the UK and the EA require more substantial foundations.

Rolling over – in charts

UK monetary aggregates are rolling over sending mixed messages to economists, strategists and investors alike (see key chart above). Growth in sterling money (M4ex) slowed to 7.9% YoY in July 2021, down from 8.8% in June 2021 and from February 2021’s recent peak of 15.3%. Growth in sterling net lending (M4Lex) slowed to 1.8% YoY in July 2021, down from 2.4% in June and from its earlier March 2020 peak of 6.6% (the “dash-for-cash”).

**Synchronised UK and EA money cycles** (Source: BoE; ECB; CMMP)

Money cycles in the UK and the EA remain highly synchronised with broad money growth peaking in February 2021 and January 2021 in the UK and EA respectively (see chart above).

**M1 as a percentage of EA and UK broad money** (Source: BoE; ECB; CMMP)

The expansion in UK and euro area (EA) broad money during the pandemic reflected deflationary forces as uncertain households increased their money holdings despite earning negative real returns and delayed consumption. Growth in narrow money (and in overnight deposits within narrow money) is the main driver of broad money growth in both regions. Narrow money accounts for 68% and 72% of broad money (M3) in the UK and EA respectively, the highest market shares in both cases. As can be seen in the chart above, the COVID-19 pandemic accelerated the pre-existing trends towards holding liquid assets. The key point here being that money sitting in overnight deposits contributes to neither economic growth nor inflation.

**UK monthly HH money flows (£bn) since January 2019** (Source: BoE; CMMP)

Monthly money flows are moderating but remain elevated in relation to pre-pandemic levels and in relation to euro area dynamics. Monthly flows of HH money holdings since March 2020 have far exceeded pre-COVID levels. The two peaks seen in the chart above show monthly flows at 5.9x (May 2020) and 4.4x (December 2020) pre-COVID levels. The chart also illustrates how these flows have followed the timings of lockdowns closely indicating a combination of forced and precautionary savings.

**UK and EA money flows as a multiple of pre-COVID levels** (Source: BoE; ECB; CMMP)

Uncertainty levels have peaked in both regions but UK monthly flows are still 1.5x pre-pandemic levels. A moderation on HH money flows was the first of three key signals from the money sector identified at the start of this year. As can be seen in the chart above, the UK is lagging the EA in terms of a return to normality in this context. Monthly HH deposit flows in the EA have been at or below pre-COVID levels since April 2021.

**Monthly flows (%, LHS) and growth rate (% YoY, RHS) in consumer credit** (Source: BoE; CMMP)

Growth in consumer credit remains weak with the exception of niche areas such as the used-car market. UK individuals borrowed no additional consumer credit in July 2021. The Bank of England noted that, “Within this, they borrowed an additional £0.1bn in ‘other’ forms of consumer credit (such as car dealership finance and personal loans), offset by net credit card repayments of £0.1bn.” (Money and Credit, July 2021).

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

The annual growth rate in consumer credit also remained weak, decreasing to -2.7% YoY in July from -2.2% YoY in June. Here again the UK is lagging the EA in terms of a return to normality (key signal #2). The YoY growth rate in consumer credit turned positive in the EA in April 2021 and has average 0.5% since then (see chart above).

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

The gap between money growth and credit demand has narrowed from recent highs but remains significant, presenting on-going challenges to policy makers (key signal #3). The ideal scenario would see a reduction in the deflationary forces that drove M3 growth during the pandemic combined with a recovery in (productive) lending to the private sector. The peak UK gap (11.4ppt) occurred in February 2021 when money supply increased by 15.3% YoY while lending grew by only 3.9% YoY. The gap narrowed to 6.1ppt in July 2021. Money supply growth slowed to 7.9% YoY but lending has also slowed to 1.8%. As can be seen from the chart above the same dynamics can be observed in both the UK and the EA.

**Monthly UK retail lending flows (£bn) and breakdown** (Source: BoE; CMMP)

The real surprise in July’s UK money supply data was the £1.4bn repayment of mortgage debt compounded by a slowdown in mortgage approvals. Resilient mortgage demand had been the key feature of UK retail finance during the pandemic, offsetting weakness in consumer credit (see chart above). In July 2021, however, HHs repaid £1.4bn of mortgage debt (red data labels in chart above). This is only the second recorded net repayment in the past decade. It followed record £18bn borrowing in June, which was boosted by the tapering off of the stamp duty holiday. Looking forward, approvals for house purchases, an indicator of future borrowing trends, fell to 75,200, the lowest level since July 2020 but above pre-pandemic levels (see chart below).

**UK approvals for house purchases** (Source: BoE; CMMP)

Conclusion

Financial markets are typically sensitive to inflexion points. The overriding message from the rolling over of UK monetary aggregates is one of slowing momentum. So-called “faster indicators” are sending the same message for August (see chart below).

**Aggregate card spending versus pre-COVID levels** (Source: ONS; CMMP)

Uncertainty may be lower than during the height of the pandemic, but any recovery is gradual at best. Sustained recoveries and reflation trades in both the UK and the EA require more substantial foundations.

Please note that the summary comments 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.

“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.

“Where next for UK consumption?”

Expect a steady release of the £150bn of excess savings

The key chart

**Aggregate card payments versus pre-COVID levels** (Source: ONS; CMMP)

The key message

UK GDP grew 4.8% YoY in 2Q21 as consumer spending rebounded following the easing of COVID-19 restrictions during the quarter. The message from the money sector, which has foreshadowed official data well, remains positive but with the risk of momentum slowing. The £150bn of “excess savings” are likely to return to consumption in a steady rather than dramatic fashion.

Spending on credit and debit cards, which has been rising since early January, accelerated further with the re-opening of non-essential retail stores on 12 April 2021. In relation to pre-COVID levels, the largest increases in spending since the latest relaxation have been on the “work-related” (31ppt) and “delayable” (30ppt) goods. In contrast, spending on “staples” has slowed (but remains above pre-COVID levels).

Spending has increased further so far in the 3Q21: social (11ppt); work-related (6ppt); delayable (2ppt) and staples (1ppt). However, it is below recent peaks in each category and below (delayable, social) or at (aggregate) pre-COVID levels.

Separately, the money sector is indicating that household uncertainty remains elevated as indicated by monthly flows of money holdings that remain 2x pre-COVID levels. On a positive note, this suggests that excess savings built up during the pandemic now exceed £150bn.

Spending on delayables is the best indicator of the extent to which excess savings are returning to the economy via sustained consumption. The evidence to date is that this is happening in a steady rather than dramatic fashion.

Where next – in charts

**Change in card spending (ppt) since 12 April relaxation versus pre-COVID levels** (Source: ONS; CMMP)

**Spending trends so far in 3Q21 (to 5 August) versus pre-COVID levels** (Source: ONS; CMMP)

**Monthly flows (£bn) of HH money holdings since January 2009** (Source: BoE; CMMP)

**CMMP estimates of build up of excess savings during the pandemic** (Source: BoE, CMMP)

**Trends on aggregate spending and spending on delayable goods versus pre-COVID levels** (Source: ONS; 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.

“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?

Steady return to normality – in charts

2Q21 trends

**Quarterly HH deposit flows 1Q18-2Q21** (Source: ECB; CMMP)

**Quarterly HH borrowing flows 1Q18-2Q21** (Source: ECB; CMMP)

**Gaps between quarterly HH lending and HH deposit flows 1Q18-2Q21** (Source: ECB; CMMP)

Three signals revisited

**Trends in monthly HH deposit flows as multiple of 2019 average** (Source: ECB; CMMP)

**Monthly consumer credit flows and YoY growth rate** (Source: ECB; CMMP)

**The gap between money and credit cycles since 1999** (Source: ECB; CMMP)

Don’t misread the message – this time it WAS different

Contribution of M1 and PSC to broad money growth since 1999 (Source: ECB; CMMP)

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

“Structure matters too”

How the structure of global debt is changing and why this matters

The key chart

**Share of government and household debt in global debt since December 2008** (Source: BIS; CMMP)

The key message

With attention focusing mainly on post-pandemic highs in the level of global debt/debt ratios, it is very easy to ignore key changes in the structure of global debt, and why these changes matter.

There has been a marked shift away from household (HH) debt to government debt, at the global level. While HH (and other types of private debt) typically cause crises, government debt typically ends them/reduces their severity. Government deficits also increase the supply of money and depress rates (contrary to popular opinion)
The structure of US and UK debt is now the mirror image of the pre-GFC period. This reduces associated risks since governments face different financial constraints to the HH and NFC sectors and cannot, as currency issuers, become insolvent
A similar but more muted shift has occurred in the euro area (EA) where the structure of debt also differs significantly across the EA’s largest economies
As currency users, EA governments also face different constraints to governments that remain issuers of their own currency. Flaws in the EU’s fiscal architecture were apparent before the pandemic. With budget hawks already calling for a return to EU fiscal rules, policy risks remain elevated
These trends are advanced economy trends not EM ones. With private sector credit accounting for 72% of EM debt, EMs face very different challenges associated mainly with the level of NFC debt and the rate of growth in HH debt (note also that EM debt is increasingly a “China-debt” story)

Global debt dynamics are a key element of CMMP analysis. It is natural to focus initially on the impact of responses to the pandemic on the level of debt. However, a failure to incorporate analysis of the structure, growth and affordability of debt at the same time can lead to false conclusions regarding investment implications. The post-COVID world is very different from the post-GFC world.

Structure matters too

**Trends in global debt and the global debt ratio since 2005** (Source: BIS; CMMP)

Much attention has focused on the impact of the public and private sector responses to the COVID-19 pandemic on the level of global debt and global debt ratios across all sectors (see chart above). All recorded new highs at the end of 4Q20. Less attention has focused, however, on the changing structure of global debt particularly in relation to the pre-GFC period. This posts sets out to correct this by highlighting five key structural changes in global debt and explaining their significance.

Five key changes

**Share of government anf household debt in global debt since December 2008** (Source: BIS; CMMP)

First, at the global level, there has been a shift away from HH debt to government debt (see chart above). This matters because (1) while private sector debt typically causes crises, public sector debt typically ends them/reduces their severity and (2) contrary to mainstream teaching, government deficits increase rather than decrease the supply of money and drive rates down.

**Trends in the share of US and UK government and household debt since 2008** (Source: BIS; CMMP)

Second, following this shift, the structure of US and UK debt is the mirror image of the pre-GFC structure (see chart above). This reduces associated risks since governments face different financial constraints to the HH and NFC sectors and cannot, if currency issuers, become insolvent.

**Trends in shares of EA government, HH and NFC debt since 2008** (Source: BIS; CMMP)

Third, more muted shifts have occurred in the euro area (EA) where the structure of debt still differs significantly across the EA’s largest economies. HH debt accounted for 27% of total EA debt in 1Q08 versus 42% in the US and the UK (see chart above). This share fell to 21% in 4Q20 versus 27% in the US and 30% in the UK respectively. Government debt has increases from 31% to 39% of EA debt versus 45% in the US and 44% in the UK respectively. At the country level, however, the share of government debt in total debt ranges from 60% in Italy to only 20% in the Netherlands (see chart below).

**Changes in structure of debt across EA’s largest economies (Source: BIS; CMMP)**

Fourth, as currency users, EA governments also face different constraints to governments that remain issuers of their own currency. Flaws in the EU’s fiscal architecture were apparent before the pandemic. With budget hawks already calling for a return to EU fiscal rules, policy risks remain elevated.

**Trends in shares of EM government, HH and NFC debt since 2008** (Source: BIS; CMMP)

Fifth, these trends are advanced economy trends not EM ones. With private sector credit accounting for 72% of EM debt, EMs face very different challenges associated mainly with the level of NFC debt and the rate of growth in HH debt (see chart above). Note also that EM debt is also increasingly a “China-debt” story. At the end of 4Q20, China accounted for 67% and 70% of total EM and EM NFC debt respectively (see chart below).

**China’s share of EM total and NFC debt since 2008** (Source: BIS; CMMP)

Conclusion

Global debt dynamics are a core element of CMMP analysis. While it is natural to focus initially on the new highs in the global debt levels and debt ratios across all sectors, it is also important not to miss the important messages associated with changes in the structure, growth and affordability of global debt.

The shift in the structure of global debt from HH debt to government debt has important implications for the severity of recessions, monetary dynamics, inflation, rates and investment risks. The nature of these implications also vary depending on whether governments are currency issuers (eg, US and UK) or currency users (eg, EA governments). The risks of a return to pre-pandemic policy mixes remain in all areas, however. Finally, EMs face very different challenges largely associated with the level of NFC debt, the growth rate in HH debt and the increasing dominance of China in EM debt.

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

“The UK reflation trade needs refuelling”

Direction versus pace of travel…

The key chart

**Trends in weekly card payments versus pre-COVID levels** (Source: ONS; CMMP)

The key message

In April 2021, I argued that investment narratives, like endurance athletes, require constant refuelling but that it was too early to expect much “refuelling” in terms of the key signals for 2021. This has been true for the UK where the direction of travel has been positive but the pace of travel has been disappointing in relation to trends observed in the euro area (EA).

Monthly flows in household (HH) money, a useful indicator of household uncertainty, have followed the timing of lockdown restrictions closely. They have fallen from £21bn in December 2020 to £7bn in May 2021 but remain 1.5x the average pre-COVID pandemic monthly flows.

CMMP analysis suggests that “excess savings” built up during the pandemic have reached £144bn (slightly below official estimates) or £137bn if a slightly higher level of precautionary savings are maintained. History reminds us that it takes time for excess savings or unanticipated sources of wealth to return in the form of consumption, however. For the first time since August 2020, UK consumers borrowed more than they paid off in May 2020 (£0.3bn) but the annual growth rate remained weak (-3.2% YoY).

So-called “faster indicators” such as UK spending on debit and credit cards send the same message. Spending continues to recover but remains below pre-pandemic levels. UK HHs are increasing spending on getting to work but spending on “delayable” goods has lost some momentum and remains below pre-COVID levels. This morning (9 July 2020), ONS statistics show GDP growing 0.8% in May 2021, the fourth consecutive month of growth, but below expectations and 3.1% below pre-COVID levels.

The UK reflation trade is in need of more sustained refuelling…

The key message in six charts

**Monthly flows of HH money holding since January 2019** (Source: BoE; CMMP)

**CMMP estimates of build up of “excess savings” during the COVID-19 pandemic** (Source: BoE, CMMP)

**Trends in UK consumer credit since January 2020** (Source: BoE; CMMP)

**Aggregate weekly card payments in 2021 versus pre-COVID levels** (Source: ONS; CMMP)

**Card payments versus pre-COVID levels by type of spending** (Source: ONS; CMMP)

**ONS estimates for monthly GDP, 2018 = 100** (Source: ONS; CMMP)

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

“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.

“More consistent than Rafa!”

Spanish MFIs’ record of negative contribution to EA mortgages

The key chart

**EA mortgage growth (% YoY) and contribution from Spanish MFIs (ppt)** (Source: ECB; CMMP)

The key message

Spanish MFIs have a more consistent record than Rafael Nada at Roland-Garros.

While Rafa has won eight of the last ten French Open men’s singles championships (2011-2020) and a record 13 titles in total, Spanish MFIs have delivered an unbroken decade of negative contributions to euro area mortgage growth.

120 consecutive months of negative contribution since April 2011.

While the YoY growth rate and contribution were both marginally negative in April 2021, the last three months have seen positive monthly flows. Are Spanish MFIs about to rejoin the EA mortgage party in 2021?

The latest bank lending survey suggests a neutral/slightly negative supply-side outlook but, in combination, four factors suggest a more positive demand-side outlook:

The HH debt ratio has fallen back in line with the EA average (63% GDP) following a decade of deleveraging
The cost of borrowing is at a record low (1.49% in April 2021)
From (1) and (2), the HH debt service ratio has fallen to 6.5%, below its LT average of 7.9% and close to a 20 year low
House prices remain 28% below their peak in real terms and estimated valuations are less extreme than elsewhere in the EA

None of these four factors are new in themselves and future developments remain “highly dependent on the recovery path and the ability of Spanish and EA policymakers to prevent cliff edges by not abruptly ending support measures” (ECB, 2021). Nonetheless, Spain remains the EA’s third largest mortgage market and mortgage debt represents c80% of total HH debt. A continued rebound in monthly mortgage flows and sustained positive contributions to EA mortgage growth would represent an important signal for investors positioned for a recovery in Europe.

More consistent than Rafa!

Spanish MFIs have a more consistent record than Rafael Nada at Roland-Garros. While Rafa has won eight of the last ten French Open men’s singles championships (2011-2020) and a record 13 titles in total, Spanish MFIs have delivered an unbroken decade of negative contributions to euro area mortgage growth – 120 consecutive months of negative contribution since April 2011 (see key chart above).

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

The outstanding stock of mortgages has fallen 23% from €663bn in April 2011 to €508bn in April 2018 (slightly above January 2021’s recent low of €506bn). Over the same period, the outstanding stock of EA mortgages has risen 27% from €3,767bn to €4,798bn. The market share of Spanish MFIs has fallen from 18% to 11% due to these divergent growth trends (see chart above).

**Stable “collective” market shares masks significant differences between the big 4** (Source: ECB; CMMP)

As an aside, the market share of German, French, Spanish and Dutch MFIs has remained remarkably stable over this period at 75%. This aggregate share trends masks very different trends at the country level, however. The market shares of German and French MFIs have risen from 26% to 30% and from 21% to 25% respectively, while the market share of Dutch MFIs has remained constant at 11%.

**YoY growth in Spanish MFI mortgages** (Source: ECB; CMMP)

**Monthly mortgage flows – three consecutive positive months** (Source: ECB; CMMP)

While the YoY growth rate and contribution were both marginally negative in April 2021, the last three months have seen positive monthly flows (see charts above). Does this meant that Spanish MFIs are about to rejoin the EA mortgage party? The latest bank lending survey suggests a neutral supply-side outlook, but four factors suggest a more positive demand-side outlook: HH debt ratios; the cost of borrowing; HH debt service ratios; and house prices and valuation.

HH debt ratios

The HH debt ratio has fallen from 86% GDP (2Q10) to 63% GDP, in line with the EA average. To mix sporting metaphors horribly, the past two decades has been a “game of two halves”.

Twenty years ago, the HH debt ratios for the EA and Spain were similar at 49% GDP and 46% GDP respectively. At their respective peaks in 2Q10, these ratios had risen to 64% GDP and 86% GDP. (Note that the BIS considers 85% GDP to be the threshold level above which HH debt becomes a constraint on future growth.). By 4Q19, the EA and Spanish debt ratios had fallen back to 58% GDP and 57% GDP respectively and ended 2020 at the same level of 63% GDP. (Note also that the increase in the debt ratio in 2020 was driven by GDP falling more than the fall in debt levels.)

Sustained HH deleveraging was a key explanatory factor behind negative growth and contributions from Spanish MFIs in the past.

Cost of borrowing

The cost of borrowing has fallen to a new low of 1.49% (April 2021). The cost of borrowing has fallen 23bp YoY and recent press articles suggest increased price competition in May and June particularly from those MFIs that lost market share during the lockdown.

**Fixed versus floating** (Source: ECB; CMMP)

Price competition is particularly strong in the fixed mortgage market. Spain has historically had a bias towards more floating rate lending than other EA economies (see chart above). However, in April 2021, the share of mortgages with a floating rate or an initial fixation of up to one year fell to 28%, slightly above the record low of 27% in March. For reference, the share of floating rate mortgage loans in the EA also hit a new low in April at 15% to total mortgage loans.

HH debt service ratios (affordability)

**Affordability risk close to twenty year low** (Source: BIS; CMMP)

The HH debt service ratio (DSR) in Spain is currently 6.5% (as at end 4Q20). This compares with a peak level of 11.7% in 3Q08 and a LT average of 7.9%. With lower debt ratios and record low costs of borrowing, it is unsurprising that affordability is not a significant demand constraint for Spanish HHs, currently.

House prices and (over)valuation

**Real YoY growth in house prices over past 20 years** (Source: BIS; CMMP)

**Real house price index trends 2010 = 100** (Source: BIS; CMMP)

House prices are 28% below their peak in real terms and valuations less extreme than elsewhere in the EA.

Spanish house prices peaked in 3Q07. They did not recover in real terms until 2Q14, almost seven years later. Despite the recovery since then, prices remain 28% below their peak level in real terms.

**Overvaluation estimates as at end 2020** (Source: ECB; CMMP)

In “Herd immunity”, I noted the resilience and risks in global housing since the COVID-19 pandemic hit, especially in advanced economies, and the fact that some of the largest increases in EA house prices during 2020 had occurred in economies where house prices were also among the most overvalued (Luxembourg, Denmark, Austria). According to ECB estimates, house prices in Spain are overvalued by around 5%, a more modest level than elsewhere in the region.

Conclusion

None of the four factors highlighted above are new in themselves and future developments remain “highly dependent on the recovery path and the ability of Spanish and EA policymakers to prevent cliff edges by not abruptly ending support measures” (ECB, 2021). Nonetheless, Spain remains the EA’s third largest mortgage market and mortgage debt represents c80% of total HH debt. A recovery in mortgage demand and sustained positive contributions to EA mortgage growth would represent an important signal of a recovery in the EA.

“Vamos, Rafa” – good luck in Friday’s semi-final against Novak!

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