Strategy – Page 2 – Chris Mallin Macro Perspectives

“Why can’t the US be more like Denmark?”

A tempting question to ask, but also the wrong one!

The key chart

Twenty-year trends in debt ratios (% GDP) broken down by type (Source: BIS; CMMP)

The key message

Denmark and the US are the only two, advanced economies that maintain absolute limits on the level of government debt. Interestingly, their public debt ratios (as opposed to debt levels) were essentially the same twenty years ago (54-55% GDP). Today, however, Denmark has the third lowest public debt ratio in the world (30% GDP), while the US has the seventh highest (103% GDP).

Unsurprisingly perhaps, while we hear little “political noise” about the Danish debt ceiling (or debt ratio), we are subjected to an overdose from the US. This leads some to ask, “Why can’t the US be more like Denmark”.

A tempting question to ask, but also the wrong one…

To understand why, we need to adopt a systemic view of the Danish and US financial systems that incorporates both public and private sector debt and reflects the reality of modern money creation.

Put simply, money creation relies on actions that add to bank deposits. Bank lending and government DEFICITS (despite what is taught in many textbooks) qualify, but in different ways. The repayment of bank loans and government SURPLUSES have the opposite effect – they destroy money.

In this context, a better question to ask is, “How do the processes of money creation in Denmark and the US differ and why does this matter?”

Total debt ratios have increased in both economies over the past two decades (see key chart above). In Denmark from 223% GDP to 246% GDP. In the US from 198% GDP to 256% GDP. The processes have been very different, however.

Denmark has effectively substituted government deficits and public debt (an asset of the non-government sector) with more private debt (a liability of the non-government sector) over the past two decades. In contrast, the US has substituted private debt – mainly household debt – with more public debt. In the process, the ratio of the stock of private debt (largely ignored by policy makers and economists) to public debt has risen from 3.2x to 7.2x in Denmark over the period. In the US, it has fallen from 2.6x to 1.5x.

The key point here it that private sector money creation faces unique supply (capital and regulation) and demand (ability of currency users to service debt) constraints. Despite more than a decade of HH sector deleveraging, for example, Denmark’s HH and NFC debt ratios remain above the levels where debt is considered a constraint on future growth. The result? Further private sector deleveraging, led by the HH sector.

Private sector models are also inherently less flexible, less stable and, in advanced economies, more prone to periods of crisis that require greater to levels of public debt to resolve/address.

While lending to the private sector is also the main source of money creation in the US, the government plays a much greater role than in Denmark. As a currency issuer, the US government does not face the same constraints as the private sector (although it does face other constraints). The US is also one of only three advanced economies where both HH and NFC debt ratios are below their respective threshold limits. In short, the structure of the US model provides more flexibility and more stability, as the response to the COVID-pandemic illustrated, and reduces the risk of crisis.

The US generates significantly more political noise about the management of government debt than Denmark, the only other country to maintain an absolute debt ceiling. This noise differential in not an accurate reflection of the relative strengths of the money creation processes in each economy. It is instead, a reflection of flawed macro thinking. Thinking that views public sector debt as a problem but largely ignores private debt and falsely equates the financial constraints of currency users and currency issuers.

The irony here is that a more accurate, systemic view of Danish and US money creations leads to a different question altogether – “Shouldn’t Denmark be more like the US?”

Why can’t the US be more like Denmark?

Twenty-year trends in public sector debt ratios (% GDP) (Source: BIS; CMMP)

Denmark and the US are the only two, advanced economies that maintain absolute limits on the level of government debt. Their public debt ratios (as opposed to debt levels) were essentially the same twenty years ago (54% and 55% GDP respectively, see graph above). Today, however, Denmark has the third lowest public debt ratio in the world (30% GDP, see graph below), while the US has the seventh highest (103% GDP).

BIS reporting nations ranked by 3Q22 public debt ratios (% GDP) (Source: BIS; CMMP)

Unsurprisingly, while we hear little political noise about the Danish debt ceiling (or debt ratio), we are subjected to an overdose of “political noise” from the US. This leads some to ask, “Why can’t the US be more like Denmark”. A tempting question to ask, but also the wrong one…

Money creation in Denmark and the US – a systemic view

To understand why, we need to adopt a systemic view of the Danish and US financial systems that incorporates both public and private sector debt and reflects the reality of modern money creation.

Money creation relies on actions that add to bank deposits, the main form of money today. Bank lending and government deficits (despite what is taught in many textbooks) qualify, but in different ways. The repayment of bank loans and government surpluses have the opposite effect – they destroy money.

In this context, a better question to ask is, “How do the processes of money creation in Denmark and the US differ and why does this matter?”

The changing nature of money creation – total debt broken down by type (% total debt) (Source: BIS; CMMP)

The graph above illustrates how Denmark has effectively substituted public debt (an asset of the non-government sector) with more private debt (a liability of the non-government sector) over the past two decades. In contrast, the US has substituted private debt – mainly household debt – with more public debt.

Twenty-year trends in private debt/public debt ratios (x) (Source: BIS; CMMP)

Note the relative scale of the stock of private sector debt (largely ignored by policy makers and economist) in relation to the stock of public sector debt over the period (see graph above). In Denmark, the ratio rose from 3.3x to almost 10x before the GFC, fell back and then rose again to 7.2x today. Again, in contrast, the US ratio has fallen from 2.6x to 1.5x over the period.

Twenty-year trends in Danish money creation (debt as % GDP) (Source: BIS; CMMP)

In other words, lending to the private sector is a far more important source of money creation in Denmark (see graph above) than in the US (see below). As an aside, the Danish government ran a budget surplus in 2022, destroying money in the process.

The key point here it that private sector money creation faces unique supply (capital and regulation) and demand (ability of currency users to service debt) constraints. Despite more than a decade of HH sector deleveraging, for example, Denmark’s HH and NFC debt ratios remain above the level where debt is considered a constraint on future growth (see graph below). For reference, the BIS considers that HH and NFC debt ratio of 85% GDP and 90% GDP represent threshold limits above which debt becomes a constraint on future growth.

HH debt ratios plotted against NFC debt ratios for selected BIS reporting nations – red lines represent BIS threshold limits (Source: BIS; CMMP)

The result? Further private sector deleveraging, led by the HH sector (see chart below). Note also that private sector models are also inherently less flexible, less stable and, in advanced economies, more prone to periods of crisis that require greater to levels of public debt to resolve/address.

Twenty-year trends in US and Danish HH and NFC debt ratios (% GDP) (Source: BIS; CMMP)

While lending to the private sector is also the main source of money creation in the US, the government plays a much greater role than in Denmark (see chart below). As a currency issuer, the US government does not face the same constraints as the private sector (although it does face other constraints). The US is also one of only three advanced economies where both HH and NFC debt ratios are below their respective threshold limits.

In short, the structure of the US model provides more flexibility and more stability, as the response to the COVID-pandemic illustrated, and reduces the risk of crisis.

Twenty-year trends in US money creation (debt as % GDP) (Source: BIS; CMMP)

Conclusion – shouldn’t Denmark be more like the US?

The irony here is that a more accurate, systemic view of Danish and US money creation leads to a different question altogether – “Shouldn’t Denmark be more like the US?”

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

“Passing Through IVb”

The winners and losers from ECB hiking

The key chart

Exposure to NFC lending (% total loans) plotted against exposure to HH deposit funding (% total deposits) (Source: ECB; CMMP)

The key message

The impact of ECB monetary policy differs at the country and bank segment levels creating relative winners and losers among banks, savers and borrowers in the process

The transmission mechanism of policy has operated largely as expected but with three striking features – the scale and pace of the policy response, the speed of the pass through to the costs of NFC borrowing, and the limited pass through to the cost of HH overnight deposits.

Current aggregate dynamics are more positive for banking sectors with relatively high exposures to retail funding and NFC lending – the Italian and Spanish banking sectors. They are less positive for banking sectors with relatively low exposures to HH funding and NFC lending – the Netherlands (see key chart above).

Important differences exist between the funding mixes of the Spanish, German and Italian banking sectors (relatively high exposures to HH deposits) and the Dutch and French banking sectors (relatively high exposures to NFC funding). Spanish banks enjoy relatively high exposures to HH ON deposit funding. They have also experienced a below average pass through to the cost of these deposits.

In contrast, French banks have higher than average funding exposures to NFC and HH deposits with agreed maturities (part of M2-M1) and have experienced relatively rapid increases in the cost of these deposits.

Turning to the other side of banks’ balance sheets, Italian, French and Spanish banks benefit from above average exposures to NFC lending. They have also experienced above average increases in NFC lending rates. Spanish banks have experienced above average increases in mortgage rates too.

Spanish dynamics dominate much of this analysis. Recent trends have been negative for Spanish borrowers and savers, but positive for Spanish banks. Spanish borrowers face above average increases in their cost of borrowing, while savers see below average increases in deposit rates. Spanish banks, in contrast, not only benefit from these trends, but they also enjoy business mixes skewed towards lending to NFCs and borrowing from HHs.

The market may not have responded well to Banco Santander’s results yesterday (the share price fell by almost 6%). But the fact that the 46% YoY increase in domestic net interest income was lost in the noise, may not have been a bad thing, at least from a PR perspective…!

The winners and losers from ECB hiking

This final post in the “Passing Through” series examines how the transmission mechanism of ECB monetary policy differs at both the country and bank segment levels and explores why these differences matter. The analysis focuses on the EA’s five largest banking markets – Germany, France, Spain, Italy and the Netherlands. Even in this small sample, the differences are real and meaningful.

Changes in EA policy, market, wholesale and retail rates (ppt) between June 2022 and February 2023 (Source: ECB; CMMP)

The transmission of ECB monetary policy in the current hiking phase has largely followed theory (see chart above). There was a rapid pass through from the policy rate (300bp) to the market rate (288bp). From here the pass through to the cost of borrowing, while incomplete, was more rapid for corporate loans (202bp) than for HH loans (127bp). Similarly, in terms of funding costs, wholesale funding reflected changes in policy rates faster than retail deposits. The key differences between the current cycle and previous cycles are the relatively rapid pass through to NFC lending rates and the relatively slow pass thought to the cost of retail deposits in the current cycle.

Exposure to NFC lending (% total loans) plotted against exposure to HH deposit funding (% total deposits) (Source: ECB; CMMP)

These high-level sector dynamics are positive for banking sectors with relatively high exposures to retail funding and NFC lending (see chart above). Among the largest EA banking sectors, Italian and Spanish banks enjoy above average exposures to both HH deposit funding (63% and 61% of total deposits respectively) and NFC lending (43% and 40% of total lending respectively). In contrast, banks in the Netherlands have relatively low exposures to HH funding (46% total deposits) and NFC lending (32% total lending).

Funding mix: NFC deposits (% total) plotted against HH deposits (% total) (Source: ECB; CMMP)

Note the contrast (see chart above) between the Spanish, German and Italian banking sectors (with relatively high exposures to HH deposits) and the Dutch and French banking sectors (with relatively high exposures to NFC funding). Note also that overnight (ON) deposits represent a relatively large percentage of HH and total deposits in the case of Spanish banks (see chart below).

HH deposits as %age of total deposits by country (Source: ECB; CMMP)

The positive news for Spanish banks does not end though. Not only do they enjoy relatively high funding exposures to HH ON deposits, but they have also seen a below average pass through to the cost of these deposits (see chart below).

HH ON deposits: Pass through plotted against % total deposits (Source: ECB; CMMP)

HH ON deposits represent 57% of total deposits in Spain compared with an average of 35% for EA banks. The pass through to Spanish ON deposits has been only 6bp compared with a EA average of 12bp. Note that while Italian and German banks also enjoy relatively high exposures to HH ON deposit funding, they have also seen above average (but still limited) pass through to the cost of these deposits (16bp and 14bp respectively).

NFC AGR deposits: Pass through plotted against % total deposits (Source: ECB; CMMP)

In contrast, French banks have higher than average funding exposures to NFC and HH deposits with agreed maturity (part of M2-M1) and have experienced relatively rapid pass throughs to the cost of these deposits. NFC deposits with agreed maturity represent 8% of French banks deposits compared with an EA average of 4% (see chart above). The cost of these deposits has risen 2.62ppt since June 2002, versus and average EA rise of 2.41ppt. (Note in passing the relatively low pass through to Spanish bank deposits here).

HH AGR deposits: Pass through plotted against % total deposits (Source: ECB; CMMP)

HH deposits with agreed maturity represent 12% of total French bank deposits compared with an EA average of 8% (see chart below). Again, the increase in the cost of these deposits in France (2.14ppt) have been higher than the EA average (1.63ppt).

NFC loans: Pass through plotted against % total loans (Source: ECB; CMMP)

The good news for the Italian, French and Spanish banking sectors is that they have (slightly) above average exposures to NFC lending and have experienced above average increases in NFC lending rates. NFC loans account for 43%, 41% and 40% of total loans in Italy, France and Spain respectively compared with an EA average of 39% (see chart above). The lowest exposure in this sample is in the Netherlands (32% total loans). The increase in the composite cost of borrowing has been highest in Spain (2.34ppt), then France (2.10ppt) and then Italy (2.02ppt). These compares with an average EA increase of 2.02ppt.

HH mortgages: Pass through plotted against % total loans (Source: ECB; CMMP)

Spanish banks have also experienced an above average increase in the mortgage lending rates (see chart above). These have increased by 2.34ppt since June 2022 compared with an average rise of 1.27pp across the EA.

Changes in EA and Spanish policy, market, wholesale and retail rates (ppt) between June 2022 and February 2023 (Source: ECB; CMMP)

This analysis illustrates how the impact of the transmission mechanism of ECB monetary mechanism varies considerably at both the country and bank segment levels.

The stand out theme here is the impact in Spain. Recent trends have been negative for Spanish borrowers and savers, but positive for Spanish banks. Spanish borrowers face above average increases in their cost of borrowing, while savers see below average increases in deposit rates. Spanish banks, in contrast, not only benefit from these trends, but they also enjoy business mixes skewed towards lending to NFCs and borrowing from HHs.

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

“Passing Through IV”

Challenges for euro area policy makers

The key chart

Changes in policy rates (ppt) by month from start of hiking cycle (Source: ECB; CMMP)

The key message

Euro area (EA) policy makers face very specific challenges arising from the unique features of the current hiking cycle.

The current ECB hiking cycle has three defining features. First, the scale and pace of the policy response makes this the most aggressive hiking cycle in ECB history. Second, the pass through from higher policy rates to the cost of overnight (ON) deposits has been very slow/limited. Third, and in contrast, the pass through to the cost of borrowing for EA corporates (NFC), while still incomplete, has been very rapid.

So what?

The first difference raises the risks of policy errors significantly. Policy makers may have plenty of “textbooks” available, but they may not have the correct “playbook” for a response of this magnitude.

In theory, the second difference limits the effectiveness of ECB policy to increase household (HH) saving and reduce consumption. In practice, however, this is much less of a challenge. EA HHs are already/still saving more and borrowing less to support consumption than they did pre-COVID. Recall the contrast here with both the US and UK experience.

The third difference raises the balance of “growth risks” strongly to the downside. The 202bp increase in the composite cost of NFC borrowing since June 2022 is almost equal to the 212bp increase experienced in the entire 32-month, 2005-08 hiking period. On top of this, banks have been tightening lending standards. This matters because (1) bank finance makes up the bulk of debt financing for EA NFCs and (2) the EA needs more, not less, productive COCO-based lending (and less unproductive FIRE-based lending).

The very real differences that exist in the transmission mechanism at the country and bank levels across the EA level complicate these challenges further – the subject of the final post in this series.

Passing Through IV

This series of posts, (“Passing Through II” – “Passing Through IV”) analyses the Bank Lending Channel (BLC) and its role in the transmission mechanism of ECB monetary policy. They focus on:

What is the BLC and how does it work?
How does the current cycle compare with the previous 2005-08 cycle?
What are the key challenges for policy markets, bankers and investors?

This penultimate post focuses on the third question and specifically on the key challenges for policy makers relating to:

The scale and pace of the policy response
The very slow/limited pass through from higher policy rates to the cost of overnight deposits
The rapid pass though from higher policy rates to the cost of NFC borrowing

The key challenges for policy makers

The scale and pace of the policy response

The current hiking cycle is the most aggressive in ECB history – a 350bp increase in the policy rate in only nine months compared with a 225bp increase over 32 months in the 2005-08 hiking cycle (see chart below).

“Monetary policy is always decided under conditions of uncertainty”
Philip Lane, 11 October 2022

Not only is the pace and scale of the current policy unique but the ramifications are far from certain given the long, variable and uncertain time lags that characterise the transmission mechanism. The belated nature of the policy response also suggests a greater risk that rates go higher and stay higher for longer than would otherwise be the case.

Changes in policy rates (ppt) by month from start of hiking cycle (Source: ECB; CMMP)

This suggests that the risks of policy errors are greater in this cycle than in previous cycles. Textbooks on the transmission mechanism of monetary policy and playbooks for the current, unique phase of monetary policy are not the same thing.

The limited pass through to the cost of overnight deposits

Changes in policy rates and cost of HH overnight deposits (ppt) by month from start of hiking cycle (Source: ECB; CMMP)

Higher interest rates provide incentives to households to save more and to postpone consumption. The challenge for the ECB so far, however, is that the pass through from policy rates to the cost of overnight deposits has been very slow/limited. The 300bp increase in the MRO rate between June 2022 and February 2023 has passed through to an increase of only 12bp in the cost of HH overnight deposits. As discussed in “Passing Through III”, EA banks are relatively liquid and flush with overnight deposits and have much less incentive to raise the rates offered on overnight deposits.

In theory, this very slow/limited pass through should limit the effectiveness of ECB policy. In practice, this is less of challenge for two reasons – (1) HHs are still saving more than they did pre-COVID, and (2) demand for consumer credit remains very subdued.

Trends in HH savings rate (% gross disposable income) (Source: ECB; CMMP)

Between 4Q02 and 4Q19, the HH savings ratio averaged 13% of gross disposable income. During the pandemic, this rose to 21% in 3Q21, a combination of forced and precautionary savings. At the end of 4Q22, the savings ratio had fallen back to 14% but remained at the higher end of “pre-pandemic norms”.

Monthly flows (EUR bn) in HH consumer credit demand (Source: ECB; CMMP)

A key theme from the messages from the EA money sector has been the consistently subdued demand for consumer credit. The 3m MVA flow fell to €1.1bn in February 2023, down from €1.2bn in January 2023, and only 0.3x the pre-pandemic average flow (see chart above). Consumer credit flows have failed to recover to their pre-pandemic levels, in contrast to trends observed in both the US and the UK. The risks to the ECB’s balancing act already lie more towards weaker growth/recession.

The rapid pass through to the cost of borrowing for NFCs

“The tightening of financing conditions and stricter credit standards are expected to weigh more strongly on (both residential) and business investment over the coming quarters.”
Philip Lane, April 2023

Changes in market rates and NFC COB (ppt) by month from start of hiking cycle (Source: ECB; CMMP

The 300bp and 288bp increase in policy and market rates between June 2022 and February 2023 has passed through to a 202bp increase in the NFC composite cost of borrowing (CCOB). Note that this pass though is almost equal to the pass though of 212bp experienced in the entire 32-month, previous cycle.

This is important for two reasons. First, bank-based finance makes up the bulk of debt financing for EA corporates. Second, the EA needs more, not less, productive COCO-based lending and less unproductive FIRE-based lending.

Unfortunately, the pass through is more rapid to the former than to the latter, with adverse, if unintended consequences for lending dynamics going forwards. To compound these trends EA banks have been reporting a tightening of credit standards throughout 2022. Lower loan volumes typically follow such tightening several quarters later.

Conclusion

The most aggressive hiking series in ECB history brings unique challenges for which there is no specific playbook. The risks of policy errors are significant and the risks to economic growth skewed clearly to the downside. The euro area relies heavily on bank finance and the region needs more, not less, productive lending and investment.

The very real differences that exist in the transmission mechanism at the country and bank levels complicate these challenges further – the subject of the final post in this series.

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

“Passing Through III”

How does the current hiking cycle compare with 2005-2008?

The key chart

Comparison of changes in EA policy, market, wholesale and retail rates (ppt) during current and previous hiking cycles (Source: ECB; CMMP)

The key message

The Bank Lending Channel (BLC) is an important element of the transmission mechanism of ECB monetary policy. It is working largely as expected during the current hiking cycle through bank funding costs and the “interest rate channel.” There are important differences however between this cycle and the previous, November 2005-July 2008 cycle.

The most striking difference between the two cycles is the scale and pace of the policy responses.

The current (belated) hiking cycle is the most aggressive in ECB history – a 350bp increase in the policy rate in only nine months, compared to an increase of 225bp over 32 months in the earlier cycle. Lenders and borrowers have had limited time to adjust. It will also take time before the full impact and effectiveness of current policy becomes clear. In the meantime, the message from the EA’s money sector is that the ECB is tightening aggressively into an already slowing economy.

The second striking difference is the very slow/limited pass through to the cost of overnight (ON) deposits (the largest portion of bank ST liabilities) in the current cycle.

The reason? Very different liquidity positions and funding mixes at the start of each cycle – loans to deposit ratios of 116% in November 2005 versus 85% in July 2022, and ON deposits to total deposits of 34% in November 2005 versus 54% in July 2022. In short, there was (and still is) little incentive for liquid banks that are still flush with overnight deposits from the COVID-periods to raise ON deposit rates quickly in the current environment. Negative news for savers and the ECB alike.

Note that there has been a more rapid pass through in the cost of new deposits with an agreed maturity (part of M2-M1). This is important context for understanding recent trends in monetary aggregates.

EA banks have experienced outflows of ST liabilities (M3) in four of the past five months. This reflects six consecutive months of overnight deposit outflows (M1). Substitution effects/inflows into better-remunerated ST deposits, and into marketable securities (M3-M2) have not been enough to compensate. They also come at a higher cost.

The third striking difference is in the pace of pass through to NFC lending rates.

The 202bp increase here in the past eight months is not only sudden, but it also almost matches the full 212bp pass through experienced over the full 32-month cycle in 2005-08. This matters because the EA needs more, not less, productive COCO-based lending and less unproductive FIRE-based lending. Unfortunately, the pass though is more rapid to the cost of former than to the cost of the latter, creating a negative incentive for productive investment. This and other important consequences are the subject of the next post.

Passing Through III

This series of three posts (“Passing Through II – Passing Through IV”) analyses the BLC and its role in the transmission mechanism of ECB monetary policy. They focus on three questions:

What is the BLC and how does it work?
How does the current hiking cycle compare with the previous 2005-08 cycle?
What are the key challenges for policy makers, bankers and investors?

How does the current hiking cycle compare with the previous 2005-08 cycle?

Changes in policy rates (ppt) by month from start of hiking cycle (Source: ECB; CMMP)

The current (belated) hiking cycle is the most aggressive in the ECB’s history in terms of both scale and pace. The policy rate (MRO) rose 350bp in the nine months between the 27 June 2022 and 22 March 2023. During the previous hiking cycle between November 2005 and July 2008, the policy rate rose only 225bp over a more extended 32-month period (see chart above).

Lenders and borrowers have had little time to adjust to this paradigm shift from the ECB – an aggressive, if belated policy response. Given the long, variable and uncertain time lags that characterises the transmission mechanism of monetary policy, it will take some time before the effectiveness and impact of the current policy becomes clear.

The message from the EA money sector is clearer, however. The ECB is tightening policy aggressively into an already slowing economy.

Changes in policy and market rates (ppt) by month from start of hiking cycle (Source: ECB; CMMP)

The pass through from policy rates to rates to market rates has been rapid, if incomplete. The 350bp increase in the MRO has passed through to a 315bp increase in 3m EURIBOR. In the 2005-2008 hiking cycle, the 225bp increase in the MRO passed through to a 260bp increase in 3m EURIBOR (see chart above). Please note that in this case, changes in policy rates in March 2023 are included. For the rest of the analysis below, the reference period ends in February 2023. Bank interest rate data is only available up to this point.

As discussed in “Passing Through II”, increases in market rates are transmitted via bank funding costs to lending rates for new loans via the interest rate channel (as well as by the repricing of outstanding variable rate loans).

Changes in policy and ON deposit rates (ppt) by month from start of hiking cycle (Source: ECB; CMMP)

A striking feature of the current, aggressive hiking cycle is the very limited pass through to the cost of bank overnight deposits (the largest portion of their ST liabilities). The 300bp increase in the MRO between June 2022 and February 2023 has passed through to increases of only 36bp and 12bp in the cost of NFC and HH overnight deposits respectively.

Changes in ON deposit rates (ppt) by month from start of hiking cycle (Source: ECB; CMMP)

The key point here is not that the pass through is incomplete – that is to be expected – but that it has been so limited. In the 2005-08 hiking cycle, the 225bp increase in the MRO passed thought to a 114bp and 56bp increase in the cost of NFC and HH overnight deposits. Interestingly, the pass of the pass through to the cost of overnight deposit has been broadly similar in both cycles (see chart above).

Trends in aggregate LDR (%) for EA banks (Source: ECB; CMMP)

Part of the explanation here lies in the different liquidity positions and funding mixes of EA banks at the start of each hiking cycle. At the start of the 2005 hiking cycle, the aggregate loans to deposit ratio for EA banks was 116%. At the end of this cycle in July 2008, it was 114%. In contrast, at the start of the current cycle, the aggregate loans to deposit ratio was only 85%, close to its recent low (see chart above).

Trends in share of ON deposits to total deposits (%) (Source: ECB; CMMP)

EA banks are also flush with overnight deposits, following the hoarding of cash by NFCs and HHs during the COVID-pandemic. At the start of the current hiking cycle, overnight deposits accounted for 54% of total deposits. This compares with 34% in November 2005. The main point here is that EA banks have much less incentive to raise the rates offered on overnight deposits.

Changes in policy rates and rates on deposit with agreed maturities (ppt) by month from start of hiking cycle (Source: ECB; CMMP)

There has been a more rapid pass through to the costs of new deposits with an agreed maturity, particular for NFCs. The NFC CIR has risen 240bp already, slightly more than the 238bp that occurred in the more extended, previous cycle. The HH CIR has increased more slowly by 163bp, compared to 255bp in the previous cycle.

Note that, deposits with an agreed maturity accounted for only 4% of total deposits in June 2022 compared with 12% in November 2005. Reflecting the interest rate trends described here, they rose to 7% of total deposits at the end of February 2023.

Growth trends in EA broad money (% YoY) and contribution of components (Source: ECB; CMMP)

The interest rate dynamics described here provide important context for the recent trends in monetary aggregates in the EA (see “Still tightening as stresses mount”). Banks are experiencing net outflows of ST liabilities and a substitution away from low-cost overnight deposits to more expensive “other ST deposits” at the margin (see charts above and below).

Monthly flows (EUR bn) in broad money and key components (Source: ECB; CMMP)

As can be seen in the chart above, EA banks have experienced outflows of ST liabilities (M3) in four of the past five months. This reflects six consecutive months of overnight deposit outflows (the blue columns). Inflows in other ST deposits (within M2-M1) and, to a lesser extent, marketable securities (within M3-M2) have not been able to compensate. As noted above, they also come at a higher cost.

Changes in market rates and composite cost of borrowing indicators (ppt) by month from start of hiking cycle (Source: ECB; CMMP)

The pass through to lending rates has been more rapid, particularly in the case of the composite cost of borrowing (COB) for NFCs. The 300bp increases in policy rates has passed through to a 202bp increase in the NFC COB and a 127bp increase in the HH COB between June 2022 and February 2023 (see chart above).

Changes in composite cost of borrowing indicators (ppt) by month from start of hiking cycle (Source: ECB; CMMP)

Note that the pass through in the COB for NFCs (202bp) in the current eight-month cycle (so far) is almost equal to the pass though of 212bp experienced in the entire 32-month, previous cycle. This matters because the EA needs more not less productive COCO-based lending and less unproductive FIRE-based lending. Unfortunately, the pass though is more rapid to the former than to the latter, with adverse, if unintended, potential consequences for lending dynamics going forward. These and other consequences are the subject of the next post.

Conclusion

In this post, I have highlighted three key differences between the current policy response and the workings of the BLC in the current hiking cycle and the previous 2005-08 hiking cycle. These are: (1) the scale and pace of the policy response; (2) the speed of the pass through to overnight deposits; and (3) the speed of the pass though the cost of borrowing for NFCs in the EA. Context has also been provided to help understand recent developments in EA monetary aggregates better. The next post explores these and other consequences in more detail.

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

“Is the US consumer starting to crack? Part 2”

Not yet, but momentum is slow sharply

The key chart

Monthly trends in US consumer credit ($bn) (Source: FED; CMMP)

The key message

Is the US consumer starting to crack? The message from the US money sector is “no, not yet.” Demand for consumer credit is moderating sharply rather than collapsing, at least so far. Given the balance between the stock of consumer debt (high) and its affordability (average), it is reasonable to expect more of the same….

The US has experienced 30 consecutive months of positive monthly consumer credit flows since August 2020. According to latest data release, however, the monthly flow of consumer credit in February 2023 fell to just over $15bn, down from $19bn in January (revised up) and down from its recent peak of $37bn in October 2022.

Nonetheless, February’s monthly flow was still slightly above the pre-pandemic average flow of just under $15bn – a sharp moderation not a collapse.

Current trends are consistent with two factors:

The consumer credit to disposable income ratio (25%) is at the upper end of its historic range, while…
…the consumer credit debt service payment ratio (6%) is only in-line with its historic average since 1980

In short, the stock of consumer debt is high in relation to disposable income, but the cost of servicing it is not.

Recall that in the face of pressures on disposable income, consumers have the option to borrow more, save less and/or consume less. Looking forward, it seems reasonable to expect further moderations in the demand for consumer credit and downward pressure on US consumption.

Whether we are seeing in a convergence in the messages from the US, UK and EA money sectors here, is the subject of the next post.

Is the US consumer starting to crack? Part 2

Last month, I noted that demand for consumer credit in the US was moderating sharply. I also argued that “while it is too early to conclude that the US consumer is cracking, it seems reasonable to expect further moderations in the demand for consumer credit, pressure on US consumption, and more convergence in the messages from the US, UK and EA money sectors in 2023”.

Monthly trends in US consumer credit ($bn) (Source: FED; CMMP)

The US has now experienced 30 consecutive months of positive monthly consumer credit flows since August 2020 (see chart above). The latest FED data release for February 2023 (published on 7 April 2023) showed an upward revision in January’s flow from $14.8bn to $19.5bn and then a fall to $15.3bn in February. This latest monthly flow remains above the pre-pandemic average flow of $14.9bn, but is well below October 2022’s recent peak of £36.9bn. The 3m MVA of monthly flows ($16.1bn) fell to 1.1x pre-pandemic flows (see chart below).

In short, momentum is slowing but the US consumer is not showing signs of cracking yet.

Monthly consumer credit flows (3m MVA) versus pre-pandemic average flows ($bn) (Source:FED; CMMP)

Consumer credit is the second largest financial liability of US households after mortgages. Over the past twenty years, it has displayed a relatively stable relationship with disposable personal income (DPI), trending between 21% and 26% of DPI (see chart below). A moderation in demand is consistent with the ratio being close to the upper end of its historic range (at 25% DPI).

Trends in the consumer credit / disposable personal income ratio (%) (Source: FED; CMMP)

The offsetting factor here is the cost of servicing consumer credit. The consumer credit debt service payment (DSP) to DPI ratio has risen from a recent low of 4.9% in 3Q21 to 5.7% in 4Q22, but this is only in-line with the long term average since 1980 (see chart below).

Trend in consumer debt service payment ratio (%) (Source: FED; CMMP)

Conclusion – expect more of the same

In the face of pressures on disposable income, consumers have the option to borrow more, save less and/or consume less. Looking forward it seems reasonable to expect further moderations in the demand for consumer credit and downward pressure on US consumption. Whether we are seeing in a convergence in the messages from the US, UK and EA money sectors here, is the subject of the next post.

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

“Passing through!”

EA mortgages and the transmission of ECB policy

The key chart

Trends in policy rate and composite cost of mortgage borrowing (Source: ECB; CMMP)

The key message

What do recent trends in the cost of euro area (EA) mortgages tell us about the transmission mechanism of ECB monetary policy?

Current ECB monetary policy is notable for both the speed and the scale of the (belated) response. Policy rates have risen 350bp since 27 July 2022, faster than in previous cycles. The speed of the transmission mechanism on the cost of new mortgages – 127bp over the same period – has been equally notable; exceeding the 123bp rise recorded over 32 months between December 2005 and July 2008. Banks and borrowers have had little time to adjust.

The speed of transmission has varied widely, however, even among the EA’s five largest mortgage markets. The cost of borrowing has increased by 174bp and 161bp in Spain and Italy respectively, for example, but by only 100bp in France.

The speed of the transmission mechanism on the cost of new mortgages bears little relationship with either the structure of loans (e.g. variable rate versus fixed rate) or the cost of borrowing at the start of the period. This suggests that country- and industry-specific factors e.g. the level of competition or central bank restrictions (as in the case of France) may be more important, in the short term.

There is a much closer relationship, however, between the speed of the transmission mechanism on the cost of borrowing on the outstanding stock of mortgages and loan characteristics. Some of the largest increases here have occurred in Estonia, Lithuania, Latvia and Finland – markets where the share of variable rate loans exceed 90% – while some of the smallest increases have occurred in the Netherlands, Germany and France – markets where the share is less than 25%.

In Spain, the EA’s fourth largest mortgage market, the share of variable rate mortgages has fallen from over 90% to 25%, in-line with the EA average. Despite this, the cost of borrowing for new and outstanding mortgages has risen faster than the EA average during the current hiking phase. This has led to political pressure domestically and questions for the ECB. The minority party in the coalition government is calling for a cap on the rates on variable loans, while the ECB considers this a matter between the banks and borrowers. Either way, seven consecutive months of net repayments since August 2022 and two consecutive months of negative YoY growth rates may be more significant.

In short, the transmission of monetary policy rates to mortgage rates (the largest segment of EA private sector credit) is both rapid and variable. Banks and borrowers have had little time to adjust to the scale and pace of current tightening. Country-and industry-specific factors are key in determining the speed of transmission on new lending. Loan characteristics are key in determining the speed of transmission on outstanding mortgages and banks’ net interest margins.

Passing through!

The current ECB policy response

Current ECB monetary policy is notable for both the speed and the scale of the (belated) response. Policy rates have risen 350bp in the space of only eight months. For context, in the last sustained period of monetary tightening between 6 December 2005 and 9 July 2008, the policy rate rose 225bp in the space of 32 months (see chart below).

Trends in ECB policy rate (%) (Source: ECB; CMMP)

The transmission mechanism – the background

The transmission mechanism of ECB monetary policy – the process through which monetary policy decisions affect the EA’s economies in general and the price level in particular – is characterised typically by long, variable and uncertain time lags. This makes predicting the precise effect of policy decisions difficult. Two factors to note:

Changes in the ECB’s monetary stance typically affect lending rates for new loans quickly (see below). However, more time may be needed to impact lending rates for banks outstanding loan portfolios.

Different loan characteristics also have a substantial impact on the speed of the transmission mechanism at the country level. These include the type of loans (variable rate versus fixed rate), the frequency of revision rates and loan maturities.

Share of variable rate mortgages (% total mortgages) over past 20 years (Source: ECB; CMMP)

There has been a shift away from variable rate mortgages since the GFC, which has only be reversed relatively recently (see chart above). Variable rate mortgages accounted for 59% of total mortgage in November 2004. This share fell to only 13% in January 2017 and stayed around this level until March last year. Since then, there has been a shift back towards variable rate mortgages. This peaked at 25% in December 2023, however, before falling back slightly to 24% in February 2024.

Loan characteristics by country (February 2023) (Source: ECB; CMMP)

As always, aggregate EA figures mask very different market structures across the EA. The share of variable rate mortgages in total new mortgages ranges from over 90% in Finland, Lithuania, Estonia and Latvia to only 4% in France, for example. Within the five EA economies that account for 85% of the region’s mortgages, this range extends from 46% in Italy to 4% in France.

Note that changes in ST rates typically have a great impact on net interest margins in countries and sectors that are characterised by floating rate lending.

The transmission mechanism in practice

Trends in policy rate and composite cost of mortgage borrowing (Source: ECB; CMMP)

Recent policy has had an immediate impact, especially (as expected) on the cost on new mortgages. The chart above illustrates trends in the policy rate (MRR) and the interest rate on new mortgage loans and outstanding mortgage loans with a maturity over five years. As can be seen, the rate on new mortgage loans (the blue line) reacts much faster than the rate on outstanding mortgage loans (the maroon line) to changes in the policy rate (the black line).

At the aggregate EA level, the cost of new mortgages has increase 127bp from 1.97% to 3.24%. This is a bigger increase than the 123bp recorded in the previous hiking cycle between December 2005 and July 2008. The cost of outstanding mortgages has increased 41bp, from 1.63% to 2.04%.

Change in CCOB (in ppt) since June 2022 (Source: ECB; CMMP)

The composite cost of new mortgages has risen 127bp since June 2022, from 1.97% to 3.24%. At the country level, the rise in the CCOB indicator has ranged widely from over 200bp in Estonia (276bp), Lithuania (275bn), Latvia (247bp), Slovakia (211bp) and Portugal (206bp) to less than 100bp in Greece (76bp), Ireland (25bp) and Malta (25bp). Among the largest five EA mortgage markets, the change has ranged from 174bp and 161bp in Spain and Italy respectively to only 119bp and 100bp in Germany and France respectively (see chart above).

Composite cost of new mortgages (%) as at end February 2023 (Source: ECB; CMMP)

The cost of new mortgages also varies widely between the five largest mortgage markets. The range extends from 3.79% and 3.76% in Italy and Germany respectively to only 2.35% in France (see chart above). France has the lowest composite cost of borrowing in the EA. Note that in addition to their relatively high exposure to fixed rate mortgages, French banks are also constrained by a limit, set by the Banque de France, on the amount they can charge for mortgages.

The speed of transmission

Change in CCOB for new mortgages plotted against loan characteristic (Source: ECB; CMMP)

The speed of the transmission mechanism on the cost of new mortgages bears little relationship with either the structure of loans (see chart above) or the cost of borrowing at the start of the period (see chart below). This suggests that country- and industry-specific factors (eg, the level of competition) may be more important, in the short term.

Change in CCOB for new mortgages plotted against CCOB in June 2022 (Source: ECB; CMMP)

There is a much closer relationship, however, between the speed of the transmission mechanism on the cost of borrowing on the outstanding stock of mortgages and loan characteristics (see chart below). These characteristics include not only the loan structure but also the frequency of revision rates and loan maturities.

Change in CCOB for outstanding mortgages plotted against loan characteristic (Source: ECB; CMMP)

In this case, some of the largest increases have occurred in Estonia, Lithuania, Latvia and Finland – markets where the share of variable rate loans exceed 90% – while some of the smallest increases have occurred in the Netherlands, Germany and France – markets where the share of variable loans is less than 25%.

What is happening in Spain?

Trends in EA and Spanish loan characteristics over past twenty years (Source: ECB; CMMP)

Spain is the EA’s fourth largest mortgage market after Germany, France and the Netherlands. The share of variable loans in Spain has fallen from over 90% (pre- and during the GFC) to 25%, in-line with the EA average.

Monthly trends in CCOB for new mortgages in EA and Spain (%) (Source: ECB; CMMP)

Despite this, the cost of borrowing for new and outstanding mortgages has risen faster than the EA average during the current hiking phase. Between June 2022 and February 2023, the cost of new mortgages in Spain increased 174bp from a below EA average 1.69% to an above EA average of 3.43% (see chart above).

Trends in ECB policy rate and composite cost of outstanding Spanish mortgage borrowing (Source: ECB; CMMP)

More importantly for domestic Spanish banks, the rates on outstanding mortgages have risen 129bp since June 2022, from a below EA average of 1.23% to an above EA average of 2.38% (see chart above).This has led to political pressure domestically and on the ECB. The minority party in the coalition government is calling for a cap on the rates on variable loans, for example.

“I’m sure that banks are ready to negotiate in order to ease the burden on households over time. It is in the banks’ interest to do so.”
ECB President Lagarde, 5 March 2023

In a 5 March 2023 interview with “El Correo”, ECB President Lagarde was asked: (1) if she had a comment for Spanish families suffering from higher rates; (2) if she thought that caps were feasible; and (3) whether Spanish banks should remunerate customer deposits. Perhaps unsurprisingly, Madame Lagarde, argued that these issues were determined by the relationship between borrowers and lenders.

Trends in Spanish monthly mortgage flows (EUR bn) (Source: ECB; CMMP)

In this context, a more telling response comes from industry dynamics instead. Spain has experienced seven consecutive months of net repayments since August 2022 (see chart above) and two consecutive months of negative YoY growth rates (see graph below).

Trends in annual growth rates in mortgages for EA’s five largest markets (Source: ECB; CMMP)

Conclusion

The transmission of monetary policy rates to mortgage rates (the largest segment of EA private sector credit) is both rapid and variable. Banks and borrowers have had little time to adjust to the scale and pace of current tightening. Country-and industry-specific factors are key in determining the speed of transmission on new lending. Loan characteristics are key in determining the speed of transmission on outstanding mortgages and banks’ net interest margins.

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

“Different balancing acts!”

The BoE and ECB face different challenges from divergent consumer credit trends

The key chart

UK and EA consumer credit flows expressed as a multiple of pre-pandemic average flows (Source: BoE; ECB; CMMP)

The key message

The Bank of England (BoE) and the ECB face different balancing acts. Both have achieved success in deflating their respective mortgage markets and slowing growth in less-productive FIRE-based lending. Divergent trends in consumer credit demand point to different challenges, however, in terms of balancing household (HH) consumption and inflation (BoE) and HH consumption and growth (ECB).

Increased borrowing is one way that HHs can offset the pressures of falling real incomes. Monthly consumer credit flows in the UK dipped slightly in February 2023 from January’s recent high, but remain 1.2x their pre-pandemic level. In contrast, monthly consumer credit flows in the EA remain well below (0.6x) their respective pre-pandemic level.

Higher interest rates are supposed to deter borrowing and hence reduce aggregate demand and inflation. Resilient UK consumer credit demand suggests that the risks to the BoE’s balancing act lie towards inflation that is more persistent. In contrast, subdued EA consumer credit demand suggests that the risks to the ECB’s balancing act lie towards weaker growth/recession. Neither are easy to manage…

Different balancing acts – the details

UK consumer credit flows

The monthly flow of UK consumer credit decreased to £1.4bn in February 2023, down from the recent high of £1.7bn in January 2023 but above December 2022’s monthly flow of £0.8bn. February’s monthly flow was 1.2x the pre-pandemic flow of £1.2bn. The 3m MVA of UK consumer credit flows remained at £1.3bn, 1.1x the pre-pandemic flow (see chart below).

Trends in UK monthly consumer credit flows (Source: BoE; CMMP)

EA consumer credit flows

The monthly flow of EA consumer credit rebounded to €1.9bn in February, but remained only 0.55x the pre-pandemic average flow of €3.4bn. The 3m MVA flow fell to €1.1bn, from €1.2bn in January, 0.33x the pre-pandemic average flow. They key point here is that, in contrast to trends observed in the UK (and the US), consumer credit flows have failed to recover to their pre-pandemic levels (see chart below).

Trends in EA monthly consumer credit flows (Source: ECB; CMMP)

Conclusion

Trends in consumer credit demand matter because increased borrowing is one way that UK and EA HHs can offset the pressures from falling disposable incomes (along with reduced savings). Consumer credit is also the second most important element of productive COCO-based lending, after corporate debt. It supports productive enterprise since it drives demand for goods and services, hence helping corporates to generate sales, profits and wages.

Higher interest rates are supposed to deter borrowing and hence reduce aggregate demand. Resilient UK consumer credit demand suggests that the risks to the BoE’s balancing act lie towards inflation that is more persistent. In contrast, subdued EA consumer credit demand suggests that the risks to the ECB’s balancing act lie towards weaker growth/recession. Neither are easy…

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

“Appropriate health warnings?”

The OBR adds a “sectoral net lending” perspective, but the message stays the same

The key chart

**Trends and forecasts for UK sector financial balances (% GDP)** (Source: OBR; CMMP)

The key message

The OBR provided more details behind their latest forecasts for the UK economy this week, including a “sectoral net lending” perspective. The message remains the same, however (or even slightly worse).

Their starting point was an unattractive one. Their end point – an unsustainable world of prolonged, twin domestic deficits counterbalanced by significant current account deficits (ie, RoW surpluses) – is no better.

The good news for Jeremy Hunt, the Chancellor of the Exchequer, is that the net financial deficit of the UK public sector is forecast to fall sharply and to trend at c2-3% of GDP throughout their forecast period.

The bad news for UK households is that their net financial position is forecast to fall from its recent (and typical) surplus to sustained deficits of between 0.1% and 0.4% GDP. In short, the UK is set to become a nation of non-savers with households also spending more of their income on servicing their debt.

The lack of appropriate health warnings and the implied structural shift in risk away from the public sector to the private sector here reflects either flaws in macro thinking and policy-making and/or the heavy hand of reverse engineering. Neither are good news.

Appropriate health warnings

The OBR provided more details behind its latest economic forecasts this week (24 November 2022). This includes a “sectoral net lending” perspective (see chart below), an important framework that links all domestic economic sectors with each other and with the RoW (and represents a core element of CMMP Analysis).

Recall that the three core sectors in a given economy – the private, public and RoW sectors – can be treated as having income and savings flows over a given period. If a sector spends less than it earns it creates a budget surplus. Conversely, if it spends more that it earns it creates a budget deficit. A surplus represents a flow of savings that leads to an accumulation of financial assets while a deficit reduces net wealth. If a sector is running a deficit it must either reduce its stock of financial assets or it must issue more IOUs to offset the deficit. If the sector runs out of accumulated financial assets, it has no choice other than to increase its indebtedness over the period it is running the deficit. In contrast, a sector that runs a budget surplus will be accumulating net financial assets. This surplus will take the form of financial claims on at least one other sector.

**Trends and forecasts for UK public sector financial balances – note reverse scale!**
(Source: OBR; CMMP)

The good news for Jeremy Hunt, the Chancellor of the Exchequer, is that the net financial deficit of the UK public sector is forecast to fall from its COVID-19 peak of £123bn (26% GDP) in 2Q20 to a deficit of £59bn (9% GDP) at the end of 4Q22. Beyond that the OBR expects the net financial deficit to trend at around £20bn (2-3% GDP) for the rest of the forecast period (see chart above, note reverse scale!).

**Trends and forecasts for UK HH financial balances** (Source: OBR; CMMP)

The bad news for UK households is that their net financial position is forecast to fall from a record surplus of £86bn (18% GDP) in 2Q20 to a deficit of £7bn (-1.2% GDP) at the end of 3Q22. Beyond that, the OBR forecasts sustained HH deficits of between £2-3bn (-0.1% to -0,4% GDP) for the rest of the forecast period (see chart above).

**Trends and forecast in HH savings ratio** (Source: OBR; CMMP)

As above, if a sector is running a deficit it must either reduce its stock of financial assets or it must issue more IOUs to offset the deficit ie, borrow more.

As noted before, the OBR assumes that the UK will become a nation of non-savers. or nearly non-savers, throughout their forecast period.They forecast that the savings ratio will fall from its “very high lockdown-induced peak” of 24% in mid-2020 to a low of zero per cent in 2023 (see chart above). Beyond that, they assume that the savings ratio will settle “at around half a per cent from 2025 onwards.” This will allow some HHs to cushion the impact of inflation on consumption but will also result in higher levels of financial inequality (see “Financial inequality and debt vulnerability”).

**Trends and forecast in HH debt service costs and debt service ratio** (Source: OBR; CMMP)

The OBR’s forecasts also highlight rising debt servicing risks for the household sector. The debt servicing cost is forecast to rise from £60bn at the end of 4Q22 (3.8% of disposable income) to £107bn at the end of 4Q23 (6.6% of disposable income) and £125bn at the end of 4Q24 (7.5% of disposable income). Beyond that, the debt service ratio is assumed to stabilise at around 7.5% of disposable income below the 9.7% level seen at the time of the GFC (see chart above).

Conclusion

To return to an enduring CMMP analysis theme – the lack of appropriate health warnings and the implied structural shift in risk away from the public sector to the private sector here reflects either flaws in macro thinking and policy-making and/or a heavy hand of reverse engineering. Neither are good news.

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

“Reallocating rather than reducing”

The impact of rising energy prices on UK spending

The key chart

**UK household card spending by type in relation to pre-pandemic levels** (Source: ONS; CMMP)

The key message

The message from the UK money sector remains one of resilient consumer spending, despite rising inflation and falling real incomes. UK households are reallocating their spending towards getting to work and staple items at the expense of spending on delayable goods and socialising, rather than reducing spending entirely. This matters because household spending accounts for 60p in every pound of UK output. The recent recovery in spending on delayable goods since mid-August is also a positive sign, although this key indicator of excess savings returning to the economy remains below pre-pandemic levels.

Re-allocating rather than reducing

In recent presentations on the outlook for UK and euro area household dynamics and consumer credit, I noted that households typically either reduce their spending and/or reallocate their spending in the face of rising energy prices. The latest ONS data on card payments suggests that UK households are still “re-allocating rather than reducing”. In other words, inflation and falling real incomes are affecting spending patterns more than overall spending levels, at least so far…

**Change (ppt) in card spending by type since 31 December 2021** (Source: ONS; CMMP)

Aggregate spending in the seven days to 1 September 2022 was the same as pre-pandemic levels (see key chart above) and 22ppt higher than at the end of December 2021 (see chart immediately above).
Spending across all categories – delayable, social, staple and work-related goods – has risen YTD most notably, if not unexpectedly, in the case of work-related spending.
Work related spending is currently 38ppt above pre-pandemic levels reflecting the impact of rising fuel prices. In contrast both spending on delayable goods such as clothing and furniture and on socialising remain below pre-pandemic levels.

**Trends in work-related spending and spending on delayables in relation to pre-pandemic levels** (Source: ONS; CMMP)

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

“The resilient UK consumer”

Inflation and falling real incomes affecting patterns more than levels of spending

The key chart

**Credit and debit card payments in relation to pre-pandemic levels** (Source: ONS; CMMP)

The key message

The message from the UK money sector is still one of resilient consumer spending, despite rising inflation and falling real incomes. Monthly spending on credit and debit cards in June 2022 was 1% above pre-pandemic levels and 6ppt above the level of monthly spending a year earlier.

UK households (HH) are increasing spending the most on getting to work and on staples. Spending on these categories was 32% and 13% above pre-pandemic levels in June 2022. Social spending was 1% above pre-pandemic levels, but spending on delayable goods such as clothing and furniture was still 16% below pre-pandemic levels.

Over the past 12 months, social spending and work-related spending have increased the most. Social spending has increases 18ppt from 83% pre-pandemic levels to 101% of pre-pandemic levels. Work related spending has increased 20ppt from 112% pre-pandemic levels to 132% pre-pandemic levels.

Delayable spending is the only spending category that (1) has fallen over the past twelve months and (2) remains below pre-pandemic levels. Delayable spending has fallen from 89% pre-pandemic levels in June 2021 to 84% pre-pandemic levels in June 2022. This matters because delayable spending is our preferred indictor regarding the extent to which excess savings are returning to the economy in a sustained fashion.

In short, the impact of rising inflation and falling real incomes is evident more on spending patterns than on the overall level of spending. UK HHs are increasing spending more on getting to work and on staples, unsurprisingly, and less on items such as clothing and furniture. Daily spending data through to 21 July 2022 is consistent with these monthly trends.

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