#threekeysignals – Page 2 – Chris Mallin Macro Perspectives

“(Re-)fuelling challenges II”

Synchronised money cycles and messages from the UK and EA

The key chart

Broad money growth (% YoY) in UK and the euro area (Source: BoE, ECB; CMMP)

The key message

UK and euro area (EA) money cycles remain highly synchronised with the message from both region’s money sectors remaining one of “slowing momentum”.

At the start of 2021, I highlighted three key signals among these messages: are monthly HH deposit flows moderating; is consumer credit recovering; and are money and credit cycles re-synching with each other? The context here being that narrow money (M1) drove the expansion of broad money (M3) in both regions during the pandemic, reflecting the DEFLATIONARY forces of heightened uncertainty, increased (forced and precautionary) savings, reduced consumption and relatively subdued demand for credit.

While monthly flows of HH deposits are well below their respective peaks, they rose in both regions in August, notably in the UK where August’s flow was 2x pre-pandemic levels. Money sitting idly in overnight deposits contributes to neither growth nor inflation. Household uncertainly remains elevated and consumption muted (see also “Delaying the delayable”). Monthly consumer credit flows remain subdued in August and YoY growth rates were -2.4% in the UK and flat in the EA. Money and credit cycles remain out-of-synch with each other, presenting challenges to policy makers and investors alike and reminding us not to confuse current money cycles with previous versions. Furthermore, not only is private sector credit demand relatively subdued, it is also increasingly driven by FIRE-based lending (largely mortgages) rather than more productive COCO-based lending (largely NFC and consumer credit).

Economies and markets have benefitted from changing policy mixes that have been necessary and appropriate. Momentum in the key drivers of a sustained recovery is slowing, however, and further refuelling is required as we enter 4Q21.

Four charts that matter

**Monthly HH deposit flows as a multiple of average 2019 monthly flows** (Source: BoE; ECB; CMMP)

While monthly flows of HH deposits are well below their respective peaks, they rose in both regions in August, notably in the UK where August’s flow was 2x pre-pandemic levels (see chart above). Money sitting idly in overnight deposits contributes to neither growth nor inflation. Household uncertainly remains elevated and consumption muted.

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

Monthly consumer credit flows remain subdued in August and YoY growth rates were -2.4% in the UK and flat in the EA (see chart above).

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

Money and credit cycles remain out-of-synch with each other (see chart above), presenting challenges to policy makers and investors alike and reminding us not to confuse current money cycles with previous versions.

**Growth rates in private sector credit by type** (Source: BoE; ECB; CMMP)

Furthermore, not only is private sector credit demand relatively subdued, it is also increasingly driven by FIRE-based lending (largely mortgages) rather than more productive COCO-based lending (largely NFC credit and consumer credit).

Conclusion

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

“Euro area leads the UK”

Money cycles remain synchronised, but the EA is leading the transition to normality

The key chart

**Trends in UK and EA broad money aggregates** (Source: BoE; ECB, CMMP)

The key message

The UK and EA money cycles remain highly synchronised but the UK is lagging the EA in terms of the phased, steady return to normality.

Narrow money drove the expansion of broad money in both cases during the pandemic, reflecting the DEFLATIONARY forces of heightened uncertainty, increased savings, reduced consumption and relatively subdued demand for credit.

Among the key signals indicating a return to normality are (1) a moderation in household deposit flows, (2) a recovery in consumer credit, and (3) a resynching of money and credit cycles.

Monthly HH deposit flows/uncertainty levels have peaked in the UK and the EA, but while June 2021’s monthly flows in the EA were slightly below pre-pandemic levels, UK flows (£10bn) remained double the pre-pandemic average. According to CMMP estimates, excess HH savings in the UK have now reached over £150bn at the end of 1H21 (below official forecasts of £160bn).

Monthly consumer credit flows have turned positive in both the UK and the EA. However, while YoY growth rates turned positive in April in the EA they remain negative (-2.2%) in the UK.

The desynchronization of money and credit cycles during the pandemic has created challenges for policy makers and bankers alike. The growth in the supply of money exceeded the growth in private sector credit by record amounts during Phase 2 of the pandemic. The gap between them peaked at 11ppt in the UK (February 2021) and 8ppt in the EA (January 2021). At the end of the 2Q21, the gaps remained at 6.4ppt in the UK and 5.3ppt in the EA. Narrower than before but still very wide in a historic context.

In previous posts, I cautioned about confusing the messages from the money sector and suggested that reflation trades needed refuelling. As we enter 2H21, it remains important to understand the messages from the money sector correctly.

Falling growth rates in broad money reflect a moderation in deflationary forces primarily. Both the UK and EA are transitioning towards a steady recovery phase albeit at a different pace. The level of HH excess savings in the UK suggests a higher gearing towards a recover in HH consumption but, to date, the EA is leading the transition.

EA leads the UK – in charts

**Trends in monthly HH deposit flows since January 2019** (Source: BoE; ECB; CMMP)

Monthly HH deposit flows/uncertainty levels have peaked in the UK and the EA, but while June 2021’s monthly flows in the EA were slightly below pre-pandemic levels, UK flows (£10bn) remained double the pre-pandemic average of £5bn (see chart above). According to CMMP estimates, excess HH savings in the UK have now reached over £150bn at the end of 1H21 (below official forecasts of £160bn).

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

Monthly consumer credit flows have turned positive in both the UK and the EA (see chart above). However, while YoY growth rates turned positive in April in the EA they remain negative (-2.2%) in the UK (see chart below).

**YoY growth in consumer credit since 2016** (Source: BoE; ECB; CMMP)

**Growth in lending minus growth in money supply since 2011** (Source: BoE; ECB; CMMP)

Conclusion

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

“Through the phases”

A steady return to normality in the euro area?

The key chart

**Monthly HH deposit flows (“uncertainty proxy”) through COVID phases** (Source: ECB; CMMP)

The key message

The message from the money sector in 2Q21 is that the euro area (EA) has entered “Phase 3” of the COVID-19 crisis – a phase characterised (so far) by a steady return to normality

Household (HH) deposit flows fell from €176bn in 1Q21 to €82bn in 2Q21 as uncertainly levels peaked and the accumulation of liquid assets slowed below pre-pandemic levels. HH borrowing flows recovered from €57bn in 1Q21 to €77bn in 2Q21, above pre-pandemic levels. Mortgage flows remained the key driver, increasing from €60bn to €72bn over the same period. Consumer credit also recovered, however, from net repayments of -€4bn in 1Q21 to additional borrowing of €2bn in 2Q21.

In a reversal of recent trends, the gap between quarterly flows of HH deposits and borrowing narrowed sharply from €170bn in 1Q21 to €5bn in 2Q21. That said, overall money and credit cycles remain out-of-synch with each other but the extent of the de-synchronisation has narrowed from the January 2021 peak.

Earlier this year, I identified three key signals among the messages from the money sector to look for in 2021: a moderation in monthly HH deposit flows; a recovery in consumer credit; and a re-synching of money and credit cycles. At the end of 2Q21, the first two signals have turned positive and the third is “less-negative.” Normality is starting to return, albeit slowly.

A key lesson from Phase 2 of the pandemic was that the expansion in broad money (M3) was a reflection of DEFLATIONARY not inflationary forces – heighted uncertainty, increased liquidity preference, delayed consumption, subdued demand for credit etc. Little wonder then, that so-called “reflation trades” ran out of steam – put simply, the messages from the money sector were misunderstood.

As we move into 2H21, and if the same deflationary forces continue to moderate, attention may switch back to private sector credit demand. Will it remain subdued, recover or roll over and will money and credit cycles move back into synch with each other?

Steady return to normality – in charts

2Q21 trends

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

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

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

Three signals revisited

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

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

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

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

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

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

“The UK reflation trade needs refuelling”

Direction versus pace of travel…

The key chart

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

The key message

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

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

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

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

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

The key message in six charts

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

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

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

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

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

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

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

“Consistent messages through atypical cycles”

Synchronised messages from the UK and EA money sectors

The key chart

**Don’t misread the messages from macro variables – this is an atypical cycle** (Source: BoE; ECB; CMMP)

The key message

It is important not to confuse the decline and recovery in economic activity over the past twelve months with typical economic cycles.

Headline growth figures in key macro variables, including monetary aggregates, have been open to misinterpretation, leading to many false narratives regarding their implications for investment decisions and asset allocation. In this context, CMMP analysis has gone beyond the headlines to identify three key signals that help to interpret current trends in the UK and EA effectively. These signals focus on HH behaviour, the consumption/growth outlook and the policy context.

The messages from the UK and EA money sectors are remarkably consistent in direction if not in magnitude.

Monthly HH deposit flows are moderating in both regions (key signal #1), especially in the EA, suggesting that uncertainty levels are falling. That said, HHs are still repaying down consumer credit (key signal #2), albeit at a slower pace (n.b. the YoY growth rate in consumer credit turned positive in the EA for the first time since last summer). Policy makers still face considerable challenges due to the on-going desynchronization of money and credit cycles, however (key signal #3). The resilience in mortgage demand and on-going house price rises bring additional challenges that complicate policy choices further.

Sustained recoveries require further moderations in HH deposit flows, a recovery in consumer credit, and a resynchronisation in money and credit cycles. The UK displays higher gearing than the EA to each of these key drivers but is lagging the EA in terms of positive signals so far…

Consistent messaging through atypical cycles

The UK and euro area (EA) money sectors have provided consistent messages regarding household (HH) behaviour, the consumption/growth outlook and the policy context in their respective regions throughout the COVID-19 pandemic.

**HH monthly money flows as a multiple of 2019 average monthly flows** (Source: BoE; ECB; CMMP)

Monthly HH deposit flows provide important insights into HH behaviour. During the pandemic, HHs in both regions increased their money holdings at elevated rates, despite earning negative returns. This behaviour contributed to neither growth nor inflation.

Deposit flows declined in both regions at the start of 2Q21 (see chart above). In the EA, monthly flows fell to €19bn in April 2021 from €62bn in March 2021. This is the first time since March 2020 that these flows have fallen below the €33bn average monthly flows seen during 2019. In the UK, monthly flows fell to £11bn in April 2021 from £16bn in March 2021, the smallest net flow since September 2020. While the direction of travel is the same in both regions, monthly money flows in the UK remain 2.3x above their 2019 average of £5bn.

**YoY growth rates in consumer credit** (Source: BoE; ECB; CMMP)

While uncertainty is falling in both regions, consumption remains subdued. On a positive note, the YoY growth rate in consumer credit in the EA turned positive (0.3%) for the first time since August 2020 (see chart above). In contrast, growth remained negative in the UK (-5.7%) albeit less negative than the historic low of -10% recorded in February 2021.

That said HHs in both regions repaid consumer credit during April 2021 (see chart below). While this is not a positive signal for growth, the scale of repayments is slowing at least. In the UK, for example, net repayments of £0.4bn was less than seen on average each month over the previous year (£1.7bn).

**Monthly flows in UK and EA consumer credit** (Source: BoE; ECB; CMMP)

The policy context remains challenging, however, especially for central bankers. The effectiveness of monetary policy relies, in part, on certain stable relationships between monetary aggregates. The desynchronization of money and credit cycles during the pandemic was unprecedented in both the UK and the EA.

**Trends in the gap between growth in lending and growth in money supply** (Source: BoE; ECB; CMMP)

The gap between YoY growth rates in private sector lending and money supply hit historic highs of 11ppt in the UK in February 2021 and 8ppt in the EA in January 2021. These gaps narrowed to 9ppt and 6ppt respectively in April. Nevertheless, they remain very wide in a historic context (see chart above).

Conclusion

To repeat, it is important not to confuse the decline and recovery in economic activity over the past twelve months with typical economic cycles.

The messages from the UK and EA money sectors are remarkable consistent in direction if not in magnitude. Monthly HH deposit flows are moderating (key signal #1), especially in the EA, suggesting that uncertainty levels are falling. That said, HHs are still repaying down consumer credit (key signal #2), albeit at a slower pace (and the YoY growth rate in consumer credit turned positive in the EA for the first time since last summer). Policy makers still face considerable challenges due to the on-going desynchronization of money and credit cycles, however. The resilience in mortgage demand and on-going house price rises bring additional challenges that complicate policy choices further.

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

“Has HH uncertainty peaked?”

An important first step in the road to euro area recovery

The key chart

**HH monthly money flows as a multiple of 2019 average monthly flows** (Source: ECB; CMMP)

The key message

The key message from the money sector at the start of 2Q21 is that the euro area (EA) has taken an important first step in the road to a sustained recovery.

**Trends in M3 growth (% YoY) and contributions (ppt) from M1 and private sector credit over the past twenty years** (Source: ECB; CMMP)

Recall that the rapid expansion in monetary aggregates during the COVID-19 pandemic was a reflection of DEFLATIONARY forces not inflationary ones, as some argue. Households (HHs) increased their money holdings (boosting M1 and M3) while simultaneously slowing consumption and repaying consumer credit. The key point here was that money sitting idly in overnight deposits contributed to neither growth nor inflation. This time, it really was different (see chart above)!

**Trends in monthly HH deposit flows since January 2021** (Source: ECB; CMMP)

At the start of 2Q21, monthly HH deposits flows fell to €19bn in April 2021 from €62bn in March 2021 (key signal #1).

This is the first time since March 2020 that these flows have fallen below the €33bn average monthly flows seen during 2019.

A sustained reduction in monthly deposit flows would indicate reduced uncertainty/improved confidence with positive implications for future consumption and economic growth.

**Trends in HH consumer credit since January 202**0 (Source: ECB; CMMP)

On a more cautious note, HHs repaid another €1bn of consumer credit (key signal #2) in April 2021, suggesting that the path to recover is still at a very early stage. The YoY growth rate in consumer credit turned positive (0.3%) for the first time since August 2020, but this was due to base effects and was despite the negative monthly flow (see chart above). HHs have repaid consmer credit in six of the past nine months.

**The widening gap between growth in lending and growth in money supply** (Source: ECB; CMMP)

Similarly, while the gap between money growth and credit growth (key signal #3) has narrowed from its recent historic high of 8ppt in January 2021 to 6ppt in April, it remains very high in a historic context (see chart above). Note that the YoY growth rate in adjusted loans to the private sector decreased to 3.2% in April 2021 from 3.6% in March 2021. Loans to NFCs fell from 5.3% to 3.2% while loans to HHs increased from 3.3% to 3.8% over the month (see chart below).

**Trends in mortgage, consumer credit and NFC lending since January 2019** (Source: ECB; CMMP)

In short, one of the three key signals for 2021 has turned positive, while the other two are “less negative.” Not time for Meatloaf to re-release an old hit yet, but welcome signs nonetheless since investment narratives require consistent refuelling.

In my next post, I will explore how and where investment risks may have shifted in the meantime.

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