…and what they mean for the economy, strategy and investments
The key chart
12-month cumulative flows (EUR bn) presented in a stylised consolidated balance sheet format (Source: ECB; CMMP)
Starting with three things about the nature of money:
Money has taken various forms over time (gold, silver etc) but comes largely in two main forms today – cash and (electronic) bank deposits
Money held electronically in the form of bank deposits represents 85% of total money in the euro area. Physical holdings in the form of bank notes and/or cash represent less than 10%
Money is “created” primarily when banks make loans, and also when governments spend (hence concepts such as the “money multiplier” and “loanable funds theory” are redundant today)
Next, three things about how money is measured:
Money is typically measured in the form of “monetary aggregates”, derived from the liabilities side of the consolidated balance sheet of monetary financial institutions (see key chart above). It is then classified according to its liquidity or degree of “moneyness” e.g. narrow money (M1, the most liquid), intermediate money (M2), and then broad money (M3), in the case of the euro area
The calculation of money supply involves adding these components together – in essence, the sum of currency in circulation plus the outstanding amount of financial instruments that have a high degree of moneyness. The simplest way to think about money, therefore, is as the short-term liabilities of the banking sector (note that longer-term liabilities are excluded from the definition of broad money as they considered portfolio instruments rather than as a means of transacting)
M3 = M1 (currency plus overnight deposits) plus M2-M1 (other ST deposits) plus M3-M2 (marketable instruments)
Money can also be calculated and understood by re-arranging the so-called “counterparts of money”, i.e. all items other than money on both sides of the consolidated balance sheet. Hence M3 in the euro area can also be calculated as:
M3 = credit to EA residents + net external assets – longer term liabilities + other counterparts
Finally, what are the three key messages from current trends in EA monetary aggregates?
The headline YoY decline in broad money in August 2023 (-1.3% YoY) reflects an on-going arbitrage in favour of the highest remunerated deposits (and also bank securities outside M3) rather than a lack of confidence in the region’s banks. The very slow/limited pass through of higher policy rates to the rates offered on overnight deposits is the key reason here and is a unique feature of the current tightening cycle. While cumulative 12-month flows into other ST deposits (€855bn) and marketable securities (€154bn) have been insufficient to compensate fully for the outflows of currency and overnight deposits (€1,226bn) they also need to be considered together with the flows into longer term bank liabilities (€298bn).
Financing flows to the private sector, while positive, are slowing very sharply. Cumulative monthly flows of credit to the private sector fell from €813bn in the 12 months to August 2022 to only €85bn in the 12 months to August 2023. Within this the respective flows of bank loans fell from €782bn to only €16bn.
This pace of adjustment in financing flows highlights the rising risk of policy errors from the ECB, which lacks a playbook for the most aggressive period of monetary tightening in its history.
Please note that the summary comments and chart above are abstracts from more detailed analysis that is available separately.
Cumulative 12-month flows fell from €782bn in August 2022 to only €16bn in August 2022.
In response to the rapid transmission of ECB monetary tightening to the cost of corporate (NFC) borrowing, EA NFCs have repaid loans in seven of the past 10 months. Cumulative 12-month flows of NFC lending fell from €390bn in the 12 months to October 2022 to only €3bn in the 12 month to August 2023.
EA households (HHs) have repaid loans in two of the past four months. Cumulative 12-month flows of HH lending fell from €285bn in the 12 months to June 2922 to only €30bn in the 12 months to August 2023. This slowdown reflects mortgage dynamics primarily.
As described in previous posts, the ECB lacks a playbook for the most aggressive period of monetary tightening in its history. The pace of adjustment in financing flows suggest that the risks of policy errors are rising sharply. The ECB had reasons to pause this month but chose instead to raise rates for the tenth time to 4%.
Philip Lane argued recently that, “all of the signals are there that monetary policy is working.” As financing flows approach a choke point, the risk is that the ECB’s blunt instruments work too well. Time to pause…
The charts that matter
The collapse in financing flows to the EA private sector since 2019 (Source: ECB; CMMP)
EA NFCs have repaid loans in seven of the past ten months (Source: ECB; CMMP)
EA HHs have repaid loans in two of the past four months (Source: ECB; CMMP)
Slowdown in financing flows to the HH sector reflects mortgage market dynamics primarily (Source: ECB; CMMP)
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
How the French case study improves our understanding of debt dynamics
The key chart
Top ten BIS reporting nations ranked by outstanding stock of PS debt ($tr) (Source: BIS; CMMP)
The key message
France provides an excellent case study for improving our understanding of global debt dynamics and their impact on economic activity and banking sector risks.
When analysing debt dynamics, policy makers and macroeconomists are vulnerable to three types of mistakes:
Mistake #2: focusing exclusively on the absolute level of PS debt
Mistake #3: failing to incorporate the “structure” of debt into their analysis
Current French debt dynamics illustrate the impact of these mistakes in practice and highlight why a more multi-faceted, analytical approach is required.
Attention typically focuses on France’s above EU-average level of public debt and Economy Minister, Bruno Le Maire’s attempts to convince markets and Brussels that France is “going back to budget discipline” (see today’s 2024 budget announcement for details).
Note, however, that France also has the fourth highest outstanding stock of PS debt in the world ($6.6tr) and the highest outstanding stock among euro area (EA) nations. The risk here is that potential PS debt vulnerabilities are either ignored or under-played. Consider three additional factors:
the level of PS indebtedness: France has the highest level of PS indebtedness (226% GDP) among EA economies (excluding Luxembourg)
the rate of excess credit growth: France has recorded the highest levels of excess PS credit growth among larger EA economies since mid-2015
affordability risks: France’s PS debt service ratio is high in absolute terms and in relation to its LT average
Each of these factors point to elevated PS debt vulnerabilities in France, but they do not tell the whole story.
The transmission mechanism of ECB monetary policy to the French economy is relatively slow. The increase in the cost of borrowing for French corporates has been lower than in the rest of the EA and the current cost of borrowing for both corporates and households is lower than the EA average too. This reflects unique, structural factors of French financial markets (bias towards fixed rate lending, maturity of NFC debt, maximum debt-service-to-income ratios etc). These factors do not eliminate France’s PS debt vulnerabilities, but they do limit their impact, at least in the short term.
In short the key message here – illustrated clearly by French debt dynamics – is that not only does private sector debt matter, but also that it needs to be considered in relation to the level of indebtedness, its rate of growth, its affordability AND its structure.
Structure matters too
The context
Top ten BIS reporting nations ranked by outstanding stock of PS debt ($tr) (Source: BIS; CMMP)
France has the fourth highest outstanding stock of private sector debt ($6.6tr) among BIS reporting nations and the highest outstanding stock among EA economies (see graph above).
While France’s share of total global PS debt has fallen slightly from 3.8% in 1Q09 to 3.3% in 1Q23, its share of euro area (EA) debt has increased from 21.7% to a new high of 28.4% over the same period (see graph below).
Trends in market share of EA private sector debt (Source: BIS; CMMP)
Improving our understanding of PS debt dynamics
Three factors point to elevated PS debt vulnerabilities in France – the level of indebtedness, the rate of “excess credit growth”, and affordability risks.
France has the highest level of PS indebtedness among EA economies (excluding Luxembourg). The PS debt ratio has risen from 145% GDP in 1Q03 (109% NFC, 36% HH) to 226% GDP in 1Q23 (160% NFC, 66% HH). The PS debt ratio has fallen from its 4Q20 peak of 241% GDP but has exceeded the Netherlands’ PS debt ratio for the past two quarters (see chart above).
France has also recorded the highest levels of excess PS credit growth among larger EA economies. Since mid-2015, France’s “relative growth factor” (RGF) of private sector credit has been the highest among the larger EA economies. The RGF measures the CAGR in PS debt versus the CAGR in nominal GDP, calculated on a rolling 3-year basis. The contrast between France’s excess credit growth and the trends in the Netherlands, Italy and Spain pre-COVID are marked (see chart above).
Affordability risks
Global affordability risks – deviation of DSR from LT average plotted against current DSR level (Source: BIS; CMMP)
The PS debt ratio is also high in absolute terms and in relation to its LT average, suggesting elevated “affordability risks” (see chart above). At the end of 1Q23, France’s PS debt service ratio was 20.5%. This was down from its 4Q20 peak of 21.5% but remains high in absolute terms and 2.7ppt above its average level since 1999.
Structure matters too
Change in cost of NFC borrowing since June 2022 plotted against current cost of NFC borrowing (July 2023) (Source: ECB; CMMP)
The transmission of ECB monetary policy to the French economy is relatively slow, however, offsetting the vulnerabilities described above. The increase in the cost of borrowing for French corporates (NFCs) has been lower than in the rest of the EA (see chart above) and the current cost of borrowing for both NFCs and households (HHs) is lower than the EA average too (see chart below).
Cost of French and EA borrowing for NFCs and HHs as of July 2023 (Source: ECB; CMMP)
These trends reflect unique structural characteristics of the French market including relative exposure to fixed-, as opposed to variable-rate, lending and the maturity of debt.
Only 41% of new loans to HHs and NFCs in France are variable rate loans compared with an average of 66% across the EA. More noticeably, less than 3% of new mortgage loans in France are variable rate compared with an average of just over 20% for the EA.
According to the Banque de France, the debt of French NFCs also remains focused on long maturities (55% of outstanding bank loans and 43% of market debt have residual maturities of 5 years or more). The average interest rate in outstanding debt is therefore increasingly gradually and remains considerably lower than the cost of new borrowing – good news for borrowers, less positive for banks’ NIMs.
Conclusion
Policy makers and economists typically obsess about public sector debt while largely ignoring PS debt (mistake #1). When attention is given to PS debt, this typically focuses on its absolute level alone (mistake #2).
Incorporating the level of indebtedness, the rate of growth and the affordability of debt improves our understanding of PS debt dynamics and their potential impact on the economy considerably. However, as this French case study shows, it is an error to ignore the structure of debt too (potential mistake #3).
The level of PS indebtedness, the rate of excess PS credit growth and the affordability of PS debt all point to elevated PS vulnerabilities in France. The structure of French PS debt limits the impact of these vulnerabilities due the relatively slow transmission of ECB monetary policy, however, at least in the short term.
In summary, structure matters too…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Private sector debt service ratios (1Q23) compared with deviations from respective LT averages since 1999 (Source: BIS; CMMP)
The key message
Private sector “affordability risk” is an increasing focus of attention as we move to a “higher-for-longer” rate environment. The focus typically centres on the US private sector. Is this justified or more a reflection that we live in a highly US-centric world of financial reporting?
The debt service ratio (DSR) is the ratio of interest payments plus amortisations to income. It provides a flow-to-flow comparison ie, the flow of debt service payments divided by the flow of income. The BIS compiles this data using a unified methodological approach, but compilation challenges mean that comparisons that include both the absolute level and the deviation from respective LT averages are more useful than comparisons of absolute levels alone. The chart above plots private sector DSRs (x-axis) for BIS reporting nations in relation to the deviation from LT averages since 1999 (y-axis).
The US private sector DSR was 14.9% at the end of 1Q23. This compares with a LT average of 15.5% and the high of 18.3% recorded in 3Q07. As can be seen, the US private sector DSR is neither high in absolute terms nor in terms of the deviation from its LT average when viewed in a global context.
The latest BIS data release suggests that attention would be focused better on “affordability risks” in developed economies including Canada, Switzerland, Sweden, France and Finland and emerging markets including Brazil, China and Korea instead. In these cases, the latest DSRs are both high in absolute terms and in relation to their respective LT averages.
Perspective matters….
Please note that the summary comments and chart above are abstracts from more detailed analysis that is available separately.
HH debt ratios (% GDP, y-axis) plotted against NFC debt ratios (% GDP, x-axis) for selected BIS reporting economies with high private sector debt levels (Source: BIS; CMMP)
The key message
The latest BIS data release (18 September 2023) provides another example of how China stands out among relatively indebted, global economies. In contrast to developments elsewhere, the debt ratios of both the corporate (NFC) sector and, to a much lesser extent, the household (HH) sector rose between 1Q22 and 1Q23 – putting the idea of a balance sheet recession on hold, at least for the time being.
In 1Q23, China’s private sector debt ratio hit a new high of 227% GDP. This is the same level reached at the peak of Spain’s debt bubble in 2Q10 and 13ppt higher than Japan’s peak back in 4Q94. As noted before, the level of bank credit to GDP is much higher in China than in other “bubble phases”, leaving the country’s banks relatively exposed to the risks of private sector indebtedness.
Affordability risks also hit a new high, with China’s private sector debt service ratio reaching 21.3%, 5.5ppt above its long-term average. China’s private sector is unique among BIS reporting economies in terms of recording a new debt service ratio high in 1Q23, although the same is also true for the HH debt service ratios in Canada, Korea and Sweden.
With growth slowing, China appears to be reverting to higher levels of corporate credit as a solution, at least in the short term. The risks associated with this familiar strategy remain high. If successful, however, it would represent a unique chapter in the history of global debt dynamics.
Putting the China balance sheet recession story on hold?
The chart below illustrates HH debt ratios plotted against NFC debt ratios for the BIS reporting nations with the highest levels of private sector indebtedness for 1Q22 and 1Q23 (excluding Hong Kong and Luxembourg).
HH debt ratios (% GDP, y-axis) plotted against NFC debt ratios (% GDP, x-axis) for selected BIS reporting economies with high private sector debt levels (Source: BIS; CMMP)
As can be seen, China and, to a much lesser extent Japan, stands out due to the fact that both debt ratios rose over the period.
In China’s case, the NFC debt ratio rose from 156% GDP to 165% GDP over the period while the HH debt ratio rose very slightly from 61% GDP to 62% GDP. In Japan, the NFC debt ratio rose from 67.9% GDP to 68.1% GDP while the HH debt ratio rose from 116.5% GDP to 117.1% GDP – marginal changes.
NFC debt ratios also rose in Korea and Denmark but the more common trend was for both ratios to fall over the period – see Switzerland, Sweden, France, Canada, the Netherlands, Norway and Belgium (in chart above).
These trends put the China balance sheet recession story on hold, at least for the time being. But, note…
Trends in Japanese, Spanish and Chinese private sector debt ratios (Source: BIS; CMMP)
The chart above (one of my favourites since 2017) illustrates trends in private sector debt ratios for Japan, Spain and China since 1981. In 1Q23, China’s private sector debt ratio hit a new high of 227% GDP. This is the same level reached at the peak of Spain’s debt bubble in 2Q10 and 13ppt higher than Japan’s peak back in 4Q94.
Trends in Japanese, Spanish and Chinese bank credit to debt ratios (Source: BIS; CMMP)
As noted before, the level of bank credit to GDP is much higher in China than in other “bubble phases”, leaving the country’s banks relatively exposed (see chart above). At the end of 1Q23, China’s bank credit to GDP ratio hit a new high of 192% GDP, well in excess of the peaks recorded in Spain (168% GDP, 2Q10) and Japan (117% GDP, 1Q90).
Trend in China’s private sector debt service ratio since 1999 (Source: BIS, CMMP)
Affordability risks also hit a new high, with a debt service ratio of 21.3%, 5.5ppt above its long-term average of 15.8% (see chart above). Note that China’s private sector is unique among BIS reporting nations in terms of the DSR being at a peak level, although the debt service ratios of the HH sectors in Canada, Korea and Sweden are also at new highs too.
Conclusion
With growth slowing, China appears to be reverting to higher levels of corporate credit as a solution, at least in the short term. The risks associated with this familiar strategy remain high. If successful, however, it would represent a unique chapter in the history of global debt dynamics.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Squeezing both sources of UK money creation simultaneously
The key chart
Forty year trends in UK debt “relative growth factors” (3Y CAGR in debt versus 3Y CAGR in nominal GDP) (Source: BIS; CMMP)
The key message
The two sources of UK money creation – government spending and bank lending – are being squeezed at the same time. This does not bode well for future growth prospects (or for the re-election prospects of the current government).
Turning both taps off at the same time
UK government and private sector debt are growing at a slower pace than nominal GDP, and at the same time.
According to the latest BIS data release, government debt has declined by -2.4% on a rolling 3-year CAGR basis to the end of 1Q23. Over the same period, nominal UK GDP has increased by 3.8%, resulting in a “relative growth factor” of -6.0ppt.
Household (HH) and corporate (NFC) debt have risen by 3.1% and 0.2% on the same basis, but again at a slower rate of growth than nominal GDP, resulting in relative growth factors of -0.6ppt and -3.5ppt respectively (see key chart above).
So what?
Some economists draw the analogy between debt to GDP ratios and the relative growth factors described above and the speed of a car and the rate of acceleration or deceleration respectively. In this context, the “UK car” is not only travelling slower, the rate of growth is also decelerating at the same time.
Why do economists often overlook (or underestimate) these trends?
For the simple season that traditional macro frameworks typically ignore private sector debt and its impact on aggregate demand.
When aggregate demand is viewed correctly as being equal to income (GDP) plus the change in debt, these dynamics become far more concerning, however – especially for an incumbent government seeking re-election.
Please note that the summary comments and chart above are abstracts from more detailed analysis that is available separately.
The risks of ignoring UK private sector credit dynamics
The key chart
Trends in UK PS debt ratio (RHS) and PSC relative growth factor (LHS) (Source: BIS; CMMP)
The key message
Central bank decision-making that appears largely “data independent” in relation to private sector credit dynamics is unlikely to produce positive economic outcomes. Instead, it increases the likelihood of policy errors, especially in credit-driven economies.
It’s far too easy to blame certain individuals here (Bailey, Lagarde, Powell – you chose). The real blame lies more in the persistently flawed nature of macro thinking that frames policy decisions, however.
The fundamental error is to ignore that aggregate demand in a credit-driven economy (like the UK) is equal to income (GDP) PLUS THE CHANGE IN DEBT
(see Schumpeter 1934, Keen 2011).
The addition of the change in debt means that, in reality, aggregate demand is far more volatile than it would be if income alone was its source (as typically assumed). This is especially true for highly indebted economies.
In my analysis, I highlight three key factors when analysing the impact of debt on economic activity: the amount of debt, the rate of change of debt, and its rate of acceleration – each measured in relation to the level of GDP.
The chart above summaries these factors visually for the UK economy. The maroon line shows the UK private sector debt ratio (% GDP), while the blue line shows the rate of growth in credit compared to the rate of growth in nominal GDP (rolling 3Y CAGR).
The first key point is that the UK private sector has been deleveraging from most of the post-GFC period. The private sector debt ratio has fallen from 185% GDP in 1Q10 to 149% GDP in 2Q23.
The second key point is that a slowdown in the rate of growth can be enough to trigger a recession – an absolute fall in debt is not required. With the rate of credit growth below the rate of nominal GDP growth for the past three quarters, the impact of further policy tightening on aggregate demand is likely to be greater than forecast officially.
In short, the risk of policy errors continues to rise.
Data Independent?
The Bank of England (BoE) is likely to raise interest rates for the 15th consecutive time to 5.5% on Thursday 21 September. Policy makers will no doubt stress that inflation in the UK remains too high and that “raising interest rates is how the BoE can help to get inflation back down.” (see, “Why have interest rates in the UK gone up?” BoE website).
Note #1, that the BoE website highlights three variables that policy makers focus on when making decisions:
How fast prices are rising now, and how that is likely to change
How the UK economy is growing now, and how that is likely to change
How many people are in work now, and how that is likely to change
Note #2, the lack of reference here to private sector debt dynamics. This is despite the fact that the BoE also argues that, “higher interest rates make it more expensive for people to borrow money and encourage people to save. Overall, that means people will tend to spend less. If people spend less on goods and services, the prices of those things tend to rise more slowly.”
Part of the problem here is that the impact of private sector debt on economic growth (variable 2) is largely absent for current macro thinking. Hence the assessment of how the UK economy is growing is likely to be based on traditional measures of income (GDP), while ignoring the impact of the change in private sector credit.
Why is this a problem?
The economist Schumpeter argued back in 1934 that, “in a growing economy, the increase in debt funds more economic activity than can be funded by the sale of existing goods and services alone.” Yet critically, traditional policy frameworks typically ignore the fact that:
Aggregate demand in a credit-driven economy is equal to income (GDP) plus the change in debt
As Professor Steve Keen argues,
“this makes aggregate demand far more volatile that it would be if income alone was its source, because while GDP changes relatively slowly, the change in debt can be sudden and extreme. In addition, if debt levels are already high relative to GDP, then the change in the level of debt can have a substantial impact in demand.”
Debunking Economics, Keen 2011
How CMMP analysis views UK debt dynamics
CMMP analysis incorporates a deep understanding of global debt dynamics. This includes not just the level of debt, but also its rate of change and its rate of acceleration – all measured with respect to the level of GDP.
Trends in UK PS debt ratio (RHS) and PSC relative growth factor (LHS) (Source: BIS; CMMP)
The key chart above illustrates these dynamics for the UK since 1983. The maroon line illustrates the private sector debt ratio – debt as a percentage of GDP. The blue line illustrates the 3Y CAGR in private sector credit versus the 3Y CAGR in nominal GDP (the CMMP “relative growth factor”).
The PS debt ratio increased from 68% GDP in 1Q83 to a peak of 185% GDP in 1Q10. The fastest rates of acceleration (peak excess credit growth) occurred in phase 1 (1Q83-1Q91) and phase 3 (1Q97 – 1Q01) as shown by the blue line above. In phase 4 (1Q01-1Q10), the debt ratio continued to rise but the rate of acceleration slowed.
The UK private sector has been deleveraging for most of the post-GFC period. The debt ratio fell to 149% GDP in 1Q23, the lowest level since 2Q02. My preferred RGF has been negative for the past three quarters. In other words, the growth in credit is slower than the growth in GDP.
They key point here is that an absolute fall in debt is not needed to cause problems, a slowdown in the rate of growth can be enough to trigger a recession (a topic that will be discussed in more detail in future posts).
With the rate of credit growth below the rate of nominal GDP growth for the past three quarters, the impact of further policy tightening on aggregate demand is likely to be greater than forecast officially.
In short, the risk of policy errors continues to rise.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
The ECB has reasons to pause, but that doesn’t meant that it will
The key chart
Changes in COB (ppt) since tightening began plotted against months since tightening began (Source: ECB; CMMP)
The key message
With the uniquely rapid “pass through” of monetary policy leading to a sharp slowdown in financing flows to the euro area private sector, the ECB has reasons to pause this month – but that doesn’t mean that it will.
Pause for thought
In a recent post, I highlighted the sharp slowdown in financing flows to the euro area (EA) private sector and the causal link to the relatively rapid pass through of ECB policy to the cost of borrowing for EA corporates (NFCs) and, to a lesser extent, the cost of borrowing for EA households (HHs).
This link was confirmed by Isabel Schnabel, a Member of the Executive Board of the ECB, in a speech on 31 August 2023.
“Bank lending flows to both firms and households have dropped sharply in recent months as banks have increased their lending rates and tightened their credit standards. Our bank lending survey confirms that the level of interest rates is a key reason behind the contraction in loan demand.”
Schnabel, 31 August 2023
The release of EA bank interest rate statistics for July 2023 on 1 September 2023 provided further evidence of the unique pace of increase in the cost of borrowing.
Trend in CCOB for NFCs since July 2008 (Source: ECB; CMMP)
The composite cost of borrowing (CCOB) for NFCs has risen 3.10ppt from 1.83% in June 2022 to 4.93% in July 2023, its highest level since November 2008 (see chart above).
The rate of increase is a defining feature of the current tightening cycle.
During the 2005-08 tightening cycle, the CCOB for NFCs rose only 1.12ppt over the same time period (13 months), and only 2.12ppt over the entire 32 month tightening period (see key chart above).
Trend in CCOB for HHs since July 2008 (Source: ECB; CMMP)
The CCOB for HHs has risen 1.78ppt from 1.97% in June 2022 to 3.75% in July 2023, its highest level since February 2012. During the 2005-08 tightening period, the CCOB for HHs rose 0.88ppt over the same time period (13 months) and 1.79ppt over the entire 32 month tightening period.
According to the most recent “Bank Lending Survey”, credit standards, particularly for loans to NFCs, are expected to tighten further in the coming months, albeit at a slower pause. The ECB also “expects the lagged effect of past policy rates to continue to dampen aggregate spending” (Schnabel, 31 August 2023).
Conclusion
In short, the ECB has reasons to pause this month but as conflicting assessments from Pierre Wunsch (a bit more probably needed) on 2 September 2023 and Mario Centeno (danger of doing too much) on 4 September 2023 suggest, that does not meant that they will.
“The lack of a historical precedent means that we can rely less on past experience”
(Schnabel, 31 August 2023)
As noted in previous posts, the ECB lacks a playbook for the most rapid period of monetary tightening in its history. The rapid pace of adjustment in financing flows experienced to date suggests that the risks of policy errors are rising rapidly with negative, potential impacts on the region’s future growth prospects.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
European banks set to reduce their reliance on public sector funding further
The key chart
Trends in monthly flows (EUR bn) of bank issuance of debt securities (Source: ECB; CMMP)
Happier times ahead for FIG DCM bankers as European banks reduce their reliance on public sector sources of funding…
So what is happening?
European banks’ reliance on public sector sources of funding is falling as TLTRO funds reach maturity. Banks plan to issue more debt to (1) compensate for the expected decline in central bank funding and (2) to comply with minimum requirements for own funds and eligible liabilities (MREL).
What does the data say?
From the latest ECB “Monetary developments in the euro area, July 2023” release we can see positive monthly flows of debt securities with a maturity of over twelve month (counterparts to M3) in every month since October 2022. Cumulative 12-month flows turning positive in December 2022 and reached €198bn in the 12 months to July 2023, their highest level since October 2007 (see chart above).
Happier times for FIG DCM bankers…
The increasingly “commoditised” FIG DCM space can be a rather soulless place for issuers and bankers alike (in my experience). The good news is that issuance is recovering and is expected to remain positive in 2023-24 (see also the European Bank Authority’s annual funding plans report, July 2023). Happier times….
The impact of ECB policy on financing flows to the private sector
The key chart
Trends in cumulative monthly flows (12 months, EUR bn) of loans to the EA private sector (Source: ECB; CMMP)
The key message
Financing flows to the euro area (EA) private sector are slowing very sharply. This is unsurprising given the relatively rapid pass through of ECB policy to the cost of borrowing for EA corporates (NFCs) and, to a lesser extent, the cost of borrowing for EA households (HHs). Note that the composite cost of borrowing for NFCs has risen 2.96ppt in the twelve months since June 2022. This compares with a 2.12ppt increases over the whole 32 month, 2005-08 tightening period.
The risk here is that the ECB lacks a playbook for the most aggressive period of monetary tightening in its history. The rapid pace of adjustment in financing flows (see key chart above) suggests that the risk of policy errors are rising rapidly with negative, potential impacts on financing flows to the EA economy and to the region’s future growth prospects. Note again, that in aggregate, NFCs have already paid back loans in seven of the past nine months. The issue here is that the EA relies heavily on bank finance and the region needs more, not less, productive lending and investment.
The warning signs are clear. How will the “data dependent” ECB respond in September?
Flowing over a cliff edge
Trends in 12-month cumulative flows of credit to the private sector (EUR bn) (Source: ECB; CMMP)
Financing flows to the euro area (EA) private sector are slowing sharply. Cumulative monthly flows of credit to the private sector totalled €197bn in the 12 months to July 2023 down from €758bn in the 12 months to July 2022 (see chart above).
Changes in composite costs of borrowing (ppt) in months after start of policy tightening (Source: ECB; CMMP)
The slowdown in financing flows is unsurprising given the relatively rapid pass through of ECB policy tightening to the cost of borrowing (COB) for NFCs and, to a lesser extent, HHs (see chart above).
The composite COB for NFCs has risen 2.96ppt in the twelve months since June 2022. This compares with a 2.12ppt increases over the 32 month, 2005-08 tightening period. The composite COB for HHs has risen 1.73ppt in the twelve months since June 2022. Again, for context, this compares with a 1.79ppt increase over the longer 32 month, 2005-08 tightening period.
The risk here is that the ECB lacks a playbook for the most aggressive period of monetary tightening in its history.
Trends in monthly and cumulative 12m flows of lending to NFCs (EUR bn) (Source: ECB; CMMP)
In aggregate, NFCs have repaid loans in six of the past nine months (see chart above). Cumulative monthly flows have fallen from €390bn in the 12 months to October 2022 to only €85bn in the 12 months to July 2023.
Trends in monthly and cumulative 12m flows of lending to HHs (EUR bn) (Source: ECB; CMMP)
In aggregate, HHs have repaid loans in two of the past three months (in each case, mortgage loans). Cumulative monthly flows have fallen from €285bn in the 12 months to June 2022 to only €40bn in the 12 months to July 2023.
Trends in cumulative monthly flows of loans to HHs, mortgages and consumer credit (EUR bn) (Source: ECB; CMMP)
The rapid slowdown in monthly flows to HHs, reflects mortgage dynamics primarily (see chart above). The composite cost of mortgages has risen 1.73ppt since June 2022. Cumulative flows have fallen from €268bn in the 12 months to August 2021 to only €40bn in the 12 months to July 2023. Despite a 1.85ppt in the composite cost of consumer credit, monthly flows have remained relatively resilient. However, as described in early posts, the demand for consumer credit has lagged well below pre-pandemic levels.
Conclusion
In summary, the rapid pace of adjustment in financing flows described above suggests that the risk of policy errors are rising rapidly with negative, potential impacts on financing flows to the EA economy and to the region’s future growth prospects. The EA relies heavily on bank finance and the region needs more, not less, productive lending and investment.
The warning signs are clear. How will the “data dependent” ECB respond in September?
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
