Uncertainty reigns and consumption remains subdued
The key chart
The UK and EA money sectors sent a clear message this week (Source: Bank of England; ECB; CMMP analysis)
The key message
The UK and euro area (EA) money sectors sent a clear message to investors this week – don’t bet on the consumer.
Uncertainty reigns among European households. Monthly flows into deposits in the UK and EA remain 1.5-2.0x the average seen in 2019, despite negative real returns.
Yes, household lending has recovered from recent lows, driven by resilient (and rising) mortgage demand. Consumer credit demand, however, remains negative/weak. UK HHs repaid £0.6bn of consumer credit in September after additional borrowing in July (£1.1bn) and August (£0.3bn). The annual growth rate fell to -4.6%, a new low since the data series began in 1994. EA HHs borrowed €1bn for consumer credit in September, down from €3bn in August and €5bn in July, but the 0.1% YoY growth rate was the slowest since consumer credit recovered back in May 2015.
High uncertainty and slowing consumer spending were in place even before the introduction of the latest round of restrictions across Europe. No wonder that Madame Lagarde was so emphatic in warning investors to expect something more dramatic in December.
A simple message in six charts
Monthly UK household deposit flows since January 2019 (Source: Bank of England; CMMP analysis)Monthly EA household deposit flows since January 2019 (Source: ECB; CMMP analysis)YoY growth rates in UK and EA mortgage and consumer credit (Source: Bank of England; ECB; CMMP analysis)Monthly UK household credit flows since January 2020 (Source: Bank of England; CMMP analysis)Monthly EA household credit flows since January 2020 (Source: ECB; CMMP analysis)Trends in EA and UK inflation versus target since 2010 (Source: Bank of England; ECB; CMMP analysis)
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately
What messages can be derived from the components and counterparts of current money growth and how do they compare with past cycles? (Source: ECB; CMMP analysis)
The key message
Broad money (M3) in the euro area (EA) is growing at its fastest rate since early 2008. However, CMMP analysis of the components and counterparts of this growth suggests that the associated “messages from the money sector” and their implications are very different.
The message in the pre-GFC period was one of (over-) confidence and excess credit demand. In contrast, the current message is one of heightened uncertainty and subdued credit demand. Today’s money growth reflects fiscal and monetary easing in response to weak private sector demand and rising savings (with added uncertainty regarding the extent to which rising savings are forced or precautionary).
The implications for inflation and policy options are clear. Inflationary pressures are likely to remain weak during the current cycle. Madame Lagarde may well signal more monetary support before the end of 2020 at this week’s ECB meeting, but the over-riding message from the EA money sector is that the route to economic recovery and higher inflation remains “fiscal, first and foremost.”
Seven charts that matter
Broad money (M3) in the euro area (EA) is growing at the fastest rate since early 2008. M3 grew 10.4% YoY in September, up from 9.5% in August. This is the fastest rate of YoY growth since April 2008 when M3 grew 10.6% YoY. However, CMMP analysis of the components and counterparts of these two growth phases suggests that the associated “messages from the money sector” are very different. Current trends are not a repeat of 2008 dynamics.
Different drivers and implications of monetary expansion – 2008 versus 2020 (Source: ECB; CMMP analysis)
Note that the components and counterparts of M3 provide different perspectives and explanations of changes in broad money. Monetary aggregates are derived from the consolidated monetary financial institutions (MFI) balance sheet and comprise monetary liabilities of MFIs and central government vis-à-vis non-MFI euro area residents.
The Eurosystem defines narrow (M1), intermediate (M2) and broad (M3) aggregates. They differ with respect the degree on “moneyness” or liquidity of the instruments included. M1, for example, comprises only currency in circulation and balances that can be converted into currency or used for cashless payments. Relative high holdings of M1 indicate a relatively high preference for liquidity and can be used as an inverse proxy for the level of private sector confidence.
The consolidated MFI balance sheet also provides the basis for analysing the counterpart of M3. All items other than M3 on the consolidated balance sheet can be rearranged to explain changes in broad money. The relationship between M3 and its counterparts rests on a simple accounting identity. What this means is that we have two identities that can be used to provide different perspectives on changes in broad money:
Components: Broad money equals M1 plus M2-M1 plus M3-M2
Counterparts: Broad money equals credit to EA residents plus net external assets minus longer term financial liabilities plus other counterparts (net)
What was the message from the money sector in the pre-GFC period? (Source: ECB; CMMP analysis)
The message in the pre-GFC period was one of (over-) confidence and excess credit demand. From a components perspective, for example, M1 was growing only 2.7% YoY in April 2008 and contributing just 1.2ppt to the overall 10.6% growth in total money. At this point M1 accounted for 43% of the outstanding stock of money. From a counterparts perspective, private sector credit was growing at 11.2% and contributing 17.6ppt to the growth in total money (offset by negative contributions from net external assets and LT financial liabilities). Credit to general government was contributing just 0.1ppt to broad money growth.
What is the message from the money sector now? (Source: ECB; CMMP analysis)
In contrast, the current message is one of heightened uncertainty and subdued credit demand. M1 grew 13.8% YoY in September 2020, up from 13.2% in August and contributed 9.4ppt to the overall 10.4% growth in broad money (versus 9.0ppt in August). M1 now accounts for 70% of the outstanding stock of money. The private sector is holding higher levels of the most liquid assets despite negative real returns on those instruments. This suggests high levels of uncertainty that have been exacerbated by the Covid-19 pandemic. (Note in passing that monthly flows showed a divergence between rising and above 2019-average household deposit flows and falling and below 2019-average NFC flows in September).
Uncertainty reigns – very different drivers of money growth (Source: ECB; CMMP analysis)
Private sector credit grew 4.6% YoY in September, unchanged from August. As before, relatively robust demand for NFC credit (7.1%) and resilient (and rising) mortgage demand (4.5%) continue to offset relative weakness in consumer credit (0.1%). However, private sector credit contributed only 5.2ppt to the overall 10.4% growth in broad money.
A key point here is that, in typical cycles, monetary aggregates and their 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. The current relationship between money and credit cycles is far from typical, however. Indeed the gap between M3 and PSC is at a historic high reflecting the fact that the euro area is only emerging very gradually from a period of debt overhang.
Counterparts to M3 – the alternative view of what is driving money growth (Source: ECB; CMMP analysis)
Today’s money growth reflects fiscal and monetary easing in response to weak private sector demand and rising savings (with added uncertainty regarding the extent to which rising savings are forced or precautionary). Credit to general government and credit to the private sector contributed 6.8ppt and 5.2ppt respectively to the 10.4% growth in broad money (see graph above). This is in direct contrast to the pre-GFC period when money expansion was driven primarily by strong, or excess, private sector credit demand (see graph below).
Contrasting contributions of private sector credit and messages for the outlook for aggregate demand (Source: ECB; CMMP analysis)
Conclusion – don’t confuse the messages
The implications for inflation and policy options are clear. Inflationary pressures are likely to remain weak during the current cycle. Madame Lagarde may well signal more monetary support before the end of 2020 at this week’s ECB meeting, but the over-riding message from the EA money sector is that the route to economic recovery and higher inflation remains “fiscal, first and foremost.”
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Unusually high monthly flows into O/N deposits (despite negative real rates of return) indicate elevated levels of uncertainty among HHs and NFCs in the euro area (Source: ECB; CMMP analysis)
The key message
July’s monetary developments in the euro area suggest that the road to recovery will be long and uncertain. Broad money (M3) is growing at the fastest rate (10.2% YoY) since May 2008. Growth rates in the components of M3 indicate that uncertainty remains very elevated at the start of 3Q20. Overnight deposits, for example, contributed 8.3ppt to the growth in broad money alone (despite negative real returns). July’s overnight deposit inflow of €151bn was the second largest inflow after March’s €249bn and was 3x the 2019 average. In contrast, growth rates in the counterparts to M3 indicate that HH consumption is recovering and the NFC’s record “dash-for-cash” has peaked. However, before anyone gets too excited – the gap between subdued PSC growth (debt overhang?) and rapid M3 growth (elevated uncertainty?) hit a twenty-year peak in July.
In short, July’s message from the EA money sector is simple: the peak of the crisis may have passed but the road to recovery is likely to be long and uncertain.
The long and uncertain road in charts
Growth rates in broad (M3) and narrow (M1) money in the euro area (% YoY) – July’s M1 growth rate exceeded 2009 and 2015 peaks (Source: ECB; CMMP analysis)
July’s monetary developments in the euro area (EA) suggest that the road to recovery will be a long and uncertain one. Broad money (M3) grew by 10.2% YoY in July from 9.2% in June, the fastest rate of growth since May 2008.
Drivers of M3 growth (percentage points) – overnight deposits (8.3ppt) remain the key driver of M3 (Source: ECB; CMMP analysis)
Narrow money (M1) grew by 13.5% YoY in July from 12.6% in June, faster than the 13.1% (Aug 09) and 11.7% (July 15) peak growth rates recorded during the GFC and after the euro crisis. M1 growth contributed 9.2ppt to the total 10.2% growth in broad money. Within M1, overnight deposits grew 14.1% YoY and contributed 8.3ppt to the overall growth in M3 alone.
Growth rates in mortgage, consumer and corporate credit – passed the crisis peaks and troughs? (Source: ECB; CMMP analysis)
Adjusted loans to the private sector grew 4.7% YoY, slightly below the 4.8% recorded in June. The annual growth rate in loans to households (HHs) was unchanged at 3.0% while the equivalent growth rate in loans to corporates (NFCs) fell very slightly to 7.0% from 7.1%. No surprises here – above trend NFC credit and resilient HH mortgage demand continue to offset weakness in HH consumer credit.
An “old favourite” chart – the gap between the growth rates in PSC and M3 is at a new twenty-year peak (Source: ECB; CMMP analysis)
The gap between the growth in money supply (M3) and the growth in private sector credit (PSC) increased to 5.5ppt, a twenty year high. This reflects the combination of extraordinary uncertainty (driving M3) and the limited progress in dealing with the debt overhang in the EA (subduing PSC).
Monthly flows into O/N deposits since January 2019 – a surprise jump in July? (Source: ECB; CMMP analysis
The monthly flow data once again provides a more nuanced picture than the headline annual growth trends. Overnight deposits, which contributed 8.3ppt to the overall growth in M3 alone, rose by €151b. This represents the second largest monthly inflow of overnight deposits (after €249bn in March 2020).
Monthly deposit flows from HHs and NFCs since January 2019 (Source: ECB; CMMP analysis)
July’s data includes a €58bn swing from negative to positive flows from non-monetary financial corporations – n.b. these flows are typically more volatile than HH and NFC flows. That said, monthly flows by HHs and NFCs also increased MoM to levels 24% and almost 50% above the average 2019 inflows. Put simply, these trends suggest that HH and NFC uncertainty levels remain very elevated.
Monthly trends in HH credit demand – passed the low point? (Source: ECB; CMMP analysis)
On a more positive note, mortgage demand remains resilient and consumer credit has recovered. Loans for house purchase increased by €19b in July versus 9€10bn in June and above the average €14bn monthly flow recorded in 2019. After record repayments between March and May 2020, monthly flows of credit for consumption have exceeded €3bn for two months in a row, closing on the €3.4bn monthly average in 2019. NFC lending data suggests that we passed the peak “dash for cash” in March and April, although July’s monthly flow of almost €16bn remains above the 2019 average of €12bn.
Putting the NFC “dash-for-cash” into an historic context (Source: ECB; CMMP analysis)
Conclusion
The message from the money sector at the start of the 3Q20 is a mixed one. Growth rates in the components of M3 indicate that uncertainty remains very elevated. In contrast, growth rates in the counterparts to M3 indicated that HH consumption is recovering and the NFC dash-for-cash has peaked. In short, while the peak of the crisis appears to have passed, the road to road to recovery is likely to remain a long and uncertain one.
Please note that the summary comments and graphs above are extracts from more detailed analysis that is available separately.
History often rhymes and occassionally repeats itself
In his 1992 analysis “Maastricht and All That”, the late economist Wynne Godley argued that, “the present situation is screaming aloud for co-ordinated reflation, but there exists neither the institutions nor an agreed framework of thought which will bring about this obviously desirable result.” Yesterday, and almost thirty years later, Fabio Panetta, a member of the ECB’s Executive Board, called for a “strong and symmetric fiscal response that offsets the economic damage from the pandemic.” Echoing Godley, Panetta stressed the risks of the current, asymmetric fiscal responses, argued why a new framework was required and made the threat to the future of the single market very clear.
From a corporate, rather than an investment perspective, one of his most interesting observations was that, “uneven fiscal support implies that a firm’s location, rather than its business model, will be the decisive factor in determining whether it survives the crisis.” A new angle?
What links Godley and Panetta’s observations is the fact that by design, the nation states of the euro area (EA) have given up sovereignty of their national currencies – they have become users rather than issuers of currency – and have, in effect, limited policy options to controlling money supply and balancing budgets. Why does this matter? In previous posts, I have argued that: (1) monetary policy has been only partially successful, at best, but also carries hidden risks; (2) asymmetric rules that are tough on deficits but weak on surpluses are inappropriate in the current situation; and (3) this is the time for co-ordinated, counter-cyclical fiscal policy across the EA.
One of Godley’s criticisms of the Maastricht Treaty was that it created no new institutions other than the ECB and yet, somewhat ironically, it is the ECB that is now leading the arguments for a new and more appropriate policy framework (see also “Fiscal, first and foremost“). Panetta concluded that, “Acting now to create the conditions for a symmetric fiscal response will help all member countries to shorten the duration of the crisis period, protect the economic base on which their future production structures and exports rely, and – perhaps most importantly – uphold the premise of a shared and indivisible European destiny.”
I would concur up until the final point – most importantly acting now will minimise the appalling human costs not only of the pandemic itself but also of the subsequent economic downturn. This should be the top priority for all. EU leaders meet tomorrow (23 April 2020) to debate their response and to consider possible funding models. Their responsibilty is immense.
Please note that summary comments above are extracts from more detailed analysis (including extended links to Modern Monetary Theory and Balance Sheet Theory) that is available separately.
