#uk – Page 7 – Chris Mallin Macro Perspectives

“Riding to the rescue”

Or are UK HHs poised to disappoint again?

The key chart

**Historic and forecast trends in HH net savings (% GDP, rolling annual average)** (Source: OBR; CMMP)

The key message

UK households (HHs) play a vital role in the UK economy and in the demand for credit. Looking forward, the key question is will the HH sector ride to the rescue or is it poised to disappoint again?

Official forecasts assume a strong recovery in HH consumption over the 2H21 as the economy starts to open. If all the additional savings accumulated during the pandemic were spent over the next four quarters, it would add c.6% to consumption in 2021 and 2020. Such a bullish scenario is unlikely for three reasons:

HHs typically save most unanticipated sources of wealth rather than spend them
The rise in savings is skewed towards high-income households who typically have lower marginal propensities to consume;
History suggests that HHs (and NFCs) typically take time to re-adjust after periods of significant financial and/or economic shock.

That said, the scale of accumulated HH savings provides support for a more rapid re-adjustment than after the GFC (the central OBR forecasts is consistent with HHs on average spending 5% of the extra deposits) and suggests that the UK has a higher level of gearing to a recovery than the euro area (EA). Potentially good news for suppliers of consumer durables…

Riding to the rescue

HHs matter

UK households (HHs) play a vital role in the UK economy and in the demand for credit. HH consumption accounts for 65p in every pound of UK GDP and lending to HHs accounts for 66p in every pound of M4 Lending. HHs are important investors in financial and non-financial assets (mainly property), with balance sheets skewed towards financial assets. The sector is typically a net saver/net lender in the UK (and other developed economies). However, notable shifts in the HH net financial balances have occurred in the post-GFC period and during the COVID-19 pandemic. A key theme in the analysis below it that the unwinding of HH savings built up during the pandemic will play an important role in determining the scale, pace and sustainability of any economic recovery.

Disappoint or ride to the rescue?

Looking forward, the key question is will the HH sector ride to the rescue or is it poised to disappoint again? The sector was poised to disappoint at the start of 2020 with risks to official forecasts tilted clearly to the downside.

**HH debt (LHS, £bn) and debt/GDP ratio (RHS, %)** (Source: BIS; CMMP)

**HH gross savings (LHS, £bn) and savings rate (RHS, %)** (Source: ONS; CMMP)

HH debt levels peaked at 96% GDP in 1Q10 and, after a period of “passive deleveraging”, stabilised at c.85% GDP from 2Q14 onwards (note that 85% GDP is the maximum threshold level above which the BIS assumes that debt becomes a constraint on future growth). Despite low debt servicing costs, HHs chose to fund consumption by slowing their rate of savings (and accumulation of net financial assets) rather than by increasing their debt levels. With real growth in disposable income slowing, however, and with the savings rates still close to historic lows, the risks to HH consumption and GDP growth were tilted clearly to the downside before COVID-19 hit.

	2019	2020e	2021e	2022e	2023e	2024e	2025e
GDP (%)	1.4	-9.9	4.0	7.3	1.7	1.6	1.7
HH cons. (ppt)	0.7	-7.1	1.8	7.0	0.8	1.1	0.8

Forecasts for GDP growth and contribution from HH consumption (Source: OBR; CMMP analysis)

Official forecasts assume a strong recovery in HH consumption over the 2H21 as the economy starts to open (see table above). After falling 11% in 2020, HH consumption is forecast to recover 2.9% in 2021, contributing 1.8ppt to GDP growth of 4.0% and then to grow 11.1% in 2022 contributing 7.0ppt to GDP growth of 7.3% (OBR, March 2021 forecasts).

What if?

If all the additional savings accumulated during the pandemic were spent over the next four quarters, it would add c6% to consumption in 2021 and 2020. In recent posts, I have noted the increase in HH deposits (“COVID-19 and the flow of financial funds in the UK”).

**HH money monthly flows and 2019 average monthy flow** (Source: BoE; CMMP)

HHs increased their deposits by £100bn in the first three quarters of 2020 and by a further £53bn in the 4Q20 alone. The OBR expects the level of “additional deposits” to reach £180bn by the middle of 2021. In the unlikely scenario that all these additional deposits were spent over the next four quarter, the OBR estimates that it would add c6% to consumption in 2021 and 2020.

Not so fast…

Such a positive scenario is unlikely for three key reasons. First, HHs typically save most unanticipated sources of wealth rather than spend them. Traditional consumption theory suggests that rather than spending all of an unanticipated increment to their wealth immediately, HHs are instead more likely to save most of it to allow for higher consumption in the future. An autumn 2020 BoE survey supports this theory. Only 10% of HHs planned to spend the additional savings built up during the pandemic. In contrast, around 66% planned to retain them in their bank account. (Note, that the first of the CMM three key charts for 2021 measures monthly HH deposit flows in relation to past trends).

**NMG survey responses on what HHs plan to do with additional savings built up during the pandemic** (Source: BoE; OBR; CMMP)

Second, the rise in savings is skewed towards high-income HHs. Another recent BoE survey notes that 42% of high-income HH were saving more and 16% saving less, compared to 23% of low-income HHs saving more and 24% saving less. This matters because high-income HHs typically have lower marginal propensities to consumer than low-income HHs. Empirical evidence suggests that annual spending typically rises by between 5-10% of unanticipated, incremental increases in wealth.

**HH net savings (%GDP) 2007-2017** (Source: ONS; CMMP)

Third, history suggests that HHs (and NFCs) typically take time to re-adjust after periods of significant financial and/or economic shock. In the aftermath of the GFC, for example, the net savings of the HH sector peaked at 6.1% GDP in 2Q10. It took 26 quarters before net savings fell below 2% GDP (4Q16).

**How COVID-19 altered the OBR’s forecasts for HH net savings** (Source: OBR; CMMP)

The COVID-19 pandemic was a greater financial, economic (and mental) shock than the GFC. In response, the HH sector’s net savings increased from 0.4% at the end of 2019 to 7.0% in 3Q20. OBR forecasts indicate that net savings increased to 8.7% at year-end and are expected to peak at 10.4% GDP in 1Q21 (4.3ppt higher than post-GFC). Their forecasts also assume a rapid re-adjustment by HHs as vaccination levels rise and the economy re-opens with HH net savings falling below 2% by 3Q22 (ie, in six quarters) and remaining below 0.5% out to 1Q26. In my view, risks to these assumptions lie to the downside ie, HH net savings will remain higher than forecast here as HHs maintain larger precautionary savings.

But, what if size does matter…

The scale of accumulated HH savings provides support, however, for a more rapid re-adjustment than after the GFC and suggest that the UK has a higher level of gearing to a recovery than the euro area (EA).

The central OBR forecasts is “consistent with HHs on average spending 5% of the extra deposits accumulated during the pandemic each year, but somewhat front loaded into 2H21 and 1H22.” In other words, the OBR forecasts suggest that c.25% of the total stock of £180bn built up during the pandemic will have been used for consumption by 1Q26. This seems a reasonable assumption, in my view.

**UK and EA HH monthly deposit flows expressed as a multiple of 2019 average monthly flows** (Source: BoE; ECB; CMMP)

Note also that the “messages from the money sector” indicate that the scale of additional deposit flows in the UK, in relation to past trends, is higher in the UK than in the EA. In December 2020, for example, the monthly flow of HH money (£20bn) was 4.5x the average monthly flow recorded in 2019. In the EA, the respective multiple was 1.8x.

Potential beneficiaries?

If correct, the rebound in HH consumption is potentially good news for suppliers of consumer durables. So-called “social consumption” will naturally benefit too, but there is only so much lost time that can be made up (you can only eat so many meals in one day!). It is reasonable to assume, therefore, that a large proportion of additional expenditure is directed towards durable goods whose consumption is more likely to have been delayed during lockdown (eg, car sales).

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

“COVID-19 and the flow of financial funds in the UK”

How did the flow of funds between sectors change?

The key chart

**Change in net aquisition of assets between first 3Qs 2020 and final 3Qs 2019 (£bn)** (Source: OBR; BoE; ONS; CMMP)

The key message

The OBR’s “Economic and fiscal outlook – March 2021” provides valuable insights into the impact of the COVID-19 pandemic on the flow of funds between the different sectors of the economy.

The UK government issued £227bn gilts in the first three quarters of 2020 to finance the support given to HHs and NFCs (and increased it net liability position by £130bn).

The BoE purchased a similar quantity of gilts in the secondary market (via APF) and financed this through the issuance of reserves. These reserves form liquid assets for the rest of the financial sector, counterbalanced by additional deposits from HHs and NFCs. Note that the net asset/liability positions of the money sector (the BoE and FIs) remained broadly unchanged at this point.

HHs increased their deposits by £102bn and their net asset position increased by £111bn. This increase in HH savings was intermediated to the UK government via the money sector, meaning that UK HHs have been the most important source of additional lending during the pandemic.

In contrast, the net lending position of NFCs and the RoW remained broadly unchanged.

Understanding how these flows will be unwound in the post-COVID period is the key to determining the speed and duration of the recovery in the UK economy. My next post will examine the HH sector dynamics in more detail.

Recall that the financial sector balances approach reognises that any net borrowing by one sector must be accompanies by net lending from another sector(s). The table below illustrates this balance in practice during the COVID-19 pandemic.

£ bn	C Bk reserves	Curr. & dep’s	Gilts	Loans and debt	Other	Total
Gov	0	-13	-227	44	65	-130
BoE APF	-259	0	231	28	0	0
FIs ex-APF	259	-204	47	-47	-47	8
HHs	0	102	1	26	-18	111
NFCs	0	123	1	-79	-30	16
RoW	0	-9	-53	27	30	-5
Balance	0	0	0	0	0	0

Net borrowing by one sector must be accompanied by net lending from another sector(s) (Source: OBR; BoE; ONS; CMMP)

COVID-19 and the UK flow of funds

The OBR’s “Economic and fiscal outlook – March 2021” provides valuable insights into the impact of the COVID-19 pandemic on the flow or funds between the different sectors of the economy. The analysis compares the patterns of financial flows between the five key sectors in the economy – HHs, NFCs, FIs, government and the RoW – in the first three quarters of 2020 and the final three quarters of 2019.

Recall that the financial sector balances approach recognises that any net borrowing of one sector must be accompanied by net lending from another sector(s).

As highlighted in my previous post, the UK government has provided unprecedented support to HHs and NFCs during the COVID pandemic. According to the OBR, this was financed (in net terms) by issuance of £227bn in gilts in the first three quarters of 2020. This compares with £34bn issuance in the final three quarters of 2019. The net liabilities of the government increased by £130bn over the period.

A similar quantity of gilts (£231bn) was purchased on the secondary market by the BoE’s Asset Purchase Facilty (APF) as part of quantitative easing (QE). The BoE financed this purchase by issuing an equivalent amount of its own liabilities (reserves). As a result the Bank’s net asset/liability position was unchanged.

The reserves issued by the BoE constitute assets for the rest of the UK financial sector. The counterpart/balance to these reserves is mainly the additional deposits from HH and NFCs that arose from the government’s support measures. Note again, that the net lending position of the financial sector remained broadly unchanged at this point.

The rise in HH deposits has been a consistent message from the money sector in 2020. The OBR notes that HH deposits increased by £102bn in the first three quarters in 2020. These savings have been intermediated to the government via the financial sector and the BoE through the flows described above. The net assets of the HH sector increased by £111bn.

The NFC sector also increased its deposits by £123bn over the period, while increasing net loans and other liabilities by £109bn. In aggregate, the net lending of NFCs changed little as a result but this masks significant differences in the experience of firms in different sectors.

Foreign investors have played a limited role in the financing the increase in UK government borrowing over the period. The net lending positions changed little over the first nine months of 2020.

Conclusion

The COVID-19 pandemic and the associate responses from the UK government led to significant changes in the flow of funds between the key economic agents. The composition of these flows changed for most sectors but the main changes in net assets and liabilities were recorded by the HH and government sectors.

UK HHs represent an important source of additional lending over this period, with the increase in their liquid savings being intermediated to the government via the money sector (financials and the BoE).

The OBR is forecasting a 4% increase in real GDP in 2021 from a fall of 9.9% in 2022, followed by growth of 7.3%, 1.7%, 1.6% and 1.7% in the next four years out to 2025 respectively. The pace and sustainability of these forecasts depend on how the financial flows described above are unwound. In the next post, I will examine the outlook for the HH and NFC sectors in more detail.

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

“Where is the value…”

…in forecasts that assume unsustainable end-games?

The key chart

**Historic and forecast trends in financial sector balances for the UK private sector, government and the RoW expressed as % GDP** (Source: OBR; CMMP)

The key message

Seen from the perspective of financial sector balances, the latest OBR forecasts for the UK economy and public finances tell us three things.

First, the UK government’s response to the COVID-19 pandemic was timely, necessary and appropriate.
Second, the financial relationship between UK households, corporates, government and the rest-of-the-world will remain broadly unchanged during 2021.
Third, (obvious and familiar) risks to the medium-term forecast remain to the downside and imply persistent and significant fiscal and current account deficits (little has changed since November 2020).

Somewhat surprisingly, given the significant event risk that the Covid-19 pandemic represents, the medium-term outcomes forecast in March 2020, November 2020 and March 2021 are broadly similar – a return to an economy characterised by large and persistent sector imbalances, with combined public and private sector deficits and an increasing reliance on the RoW as a net lender.

This scenario is as unsustainable post-COVID as it was pre-COVID, and leaves the reader wondering about the value of official forecasts in presenting an accurate outlook for the future financial interactions between the key UK economic agents.

Please note that the summary comments and chart above are extracts from more detailed analysis that is available seperately. Please also note that subsequent posts will dig out the “hidden value”!

“If you only read one page”

What to look for in the OBR’s forecasts (and where)

The key chart (from November 2020)

**The chart that said so much last November – historic and forecast trends in financial sector balances for the UK private sector, UK government and RoW expressed as % GDP** (Source: OBR; CMMP)

The key message

The Office for Budget Responsibility (OBR) will publish its latest forecasts in their “Economic and fiscal outlook – March 2021”, alongside the Chancellor’s budget tomorrow (3 March 2021)

The report is typically over 200 pages long and contains much detailed work, analysis and scenario planning. Very helpfully, it also includes one page (typically around page 65/66) that gives the reader immediate insights into the reliance and/or confidence that can be placed on the rest of the forecasts. The page is headed, “sectoral net lending” and, as the name suggests, links directly to CMMP’s preferred financial sector balances framework.

In November last year, this page illustrated clearly the risks to the rest of the OBR’s forecasts for UK growth and for the level of government borrowing. First, they assumed unprecedented levels of dynamism from both the UK household and corporate sectors and behavioural trends from these sectors and from the RoW that contrasted sharply with those seen after the GFC. Second, while they claimed that “sectoral net lending positions return to more usual levels,” this did not make them sustainable.

It is unusual, but equally very helpful, that one page can tell us so much about the truth behind the headlines that will dominate tomorrow’s news and Thursday’s papers…

“Patience, patience…”

Three key signals – January 2021 update

The key chart

**The biggest fail so far – money and credit cycles diverge even further in January 2021** (Source: BoE; ECB; CMMP)

Tke key message

Investors waiting in anxious anticipation for reflationary messages from the money sector will require some patience yet.

January 2020’s money supply data shows that households (HHs) in the UK and euro area (EA) continue to increase their holdings of liquid assets, money and credit cycles are diverging even further (to new highs), and consumer credit remains very weak. In other words, behind the headline figures, rising money supply in both regions remains a function of deflationary rather than inflationary forces – elevated HH uncertainty, relatively subdued demand for credit, and weak HH consumption. The drivers and implications of rapid money growth in the UK and the EA are very different from past cycles. Behind the headlines, and with three fails so far, the message from the UK and EA money sectors remains the same – “not so fast”.

Three key signals – January 2021

**Fail #1 – monthly flows in HH money holdings expressed as a multiple of 2019 average monthly flows** (Source: BoE; ECB; CMMP)

HHs in the UK and the EA continue to increase their holdings of highly liquid assets. In response to the COVID-19 pandemic, the levels of forced and precautionary savings have risen sharply. Today’s (1 March 2021) data release from the BoE, shows UK HHs increasing their money holdings by £18.5bn in January 2021, 4x the average monthly flows recorded in 2019. This is despite the fact that the effective interest rate paid on new time deposits remains at the lowest level (0.42%) since the series began. As noted, in my previous post, January’s monthly flows of HH deposits in the EA (€60bn) also remained almost 2x their 2019 average.

Money sitting idly in savings accounts contributes to neither GDP nor inflation.

**Fail #2 – the gap between the money and credit cycles have widened to new record levels** (Source: BoE; ECB; CMMP)

Rather than re-synching with each other, money and credit cycles in both regions widened to historic degrees in January 2021. The gap between the YoY growth in UK money (15.0%) and lending (4.4%) widened to a record 10.6ppt in January, while the gap between EA money (12.5%) and lending (4.4%) widened to 8.1ppt. Credit demand remains relatively subdued in both regions, despite the low cost of borrowing, while money supply has accelerated.

Fail #3 – growth rates (% YoY) of consumer credit in the UK and EA (Source: BoE; ECB; CMMP)

Consumer credit growth remains very weak. In the UK, HHs made net repayments of consumer credit of £2.4bn, the largest repayment since May 2020. The annual growth rate of -8.9% is yet another series low since the series began in 1994. Similarly, the -2.5% fall in consumer credit in the EA was the weakest level since February 2014.

Note that consumer credit represents one section of more productive COCO-based lending. It supports productive enterprise since it drives demand for goods and services, hence helping NFCs to generate sales, profits and wages. As before, with HHs hoarding cash and lockdown measure remaining in place, this weakness in consumer credit is not unexpected.

Conclusion

I have explained previously that the drivers and implications of rapid money supply growth in the UK and the EA are very different from past cycles and that the message from the money sectors in both regions for investors positioned for a sustained rise in inflation was, “not so fast.” The message from January’s data releases remains the same. Patience, patience…

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

“Three key charts for 2021”

And the trends that investors SHOULD be looking for…

The key chart

**Growth rates (% YoY) in UK and EA broad money aggregates** (Source: BoE; ECB; CMMP)

The key message

Should investors positioned for an upturn in inflation and sustained outperformance from cyclical and value plays and/or shorter duration trades be hoping for stronger or weaker money supply growth in the UK and EA in 2021?

Contrary to the popular narrative, the answer is likely to be the latter not the former. In this post, I summarise why this is the case and highlight the three key charts to follow in 2021.

Over the past decade, we have witnessed a sustained shift in the components of broad money supply (M3) with greater contribution coming from holdings of the most liquid assets ie, narrow money (M1). The reaction of UK and EA households to the COVID-19 pandemic has accelerated this trend, as levels of forced and precautionary savings have risen sharply, particularly in the UK.

The challenge for inflation hawks here is that money sitting idly in savings accounts contributes to neither GDP nor inflation.

Analysis of the counterparts of monetary aggregate highlights the extent to which money and credit cycles are diverging in both regions. Within subdued overall levels of private sector credit demand, relatively robust NFC credit and resilient mortgage demand offset weakness in consumer credit during 2020. Weakness in consumer credit was more noticeable in the UK, where net repayments of £17bn made 2020 the weakest year for consumer credit on record.

There are three key signals among the messages from the money sector in 2021 to look for:

First, a moderation in monthly deposit flows
Second, a re-synching of money and credit cycles
Third, a recovery in consumer credit.

Trends in 2020, suggest that the UK has a relatively high gearing to each of these trends.

The charts that mattered in 2020

**Share of narrow money in UK and EA broad money since 2010** (Source: ECB; BoE; CMMP)

Over the past decade, we have witnessed a sustained shift in the components of broad money supply (M3) with greater contribution coming from holdings of the most liquid assets ie, narrow money (M1). At the end of 2010, M1 accounted for 46% and 51% of M3 in the UK and EA respectively. By the end of 2020, these shares had risen to 67% and 71% respectively (see chart above).

In other words, changes in holdings of notes and coins and overnight deposits are having a greater impact on the behaviour of money supply. As noted in, “The yawning gap”, for example, M1 contributed 10.7ppt to the 12.3% growth in EA M3 in 2020.

**Monthly flows of HH money in the UK** (Source: BoE; CMMP)

The reaction of UK and EA households to the COVID-19 pandemic has accelerated this trend, as levels of forced and precautionary savings have risen sharply.

The first COVID-related death in the UK was recorded on 5 March 2020 and the first lockdown began 18 days later on the 23 March 2020. UK households increased their money holdings by £14bn, £17bn and £27bn in March, April and May 2020 respectively. This £58bn increase in holdings was greater than the total flow of £55bn recorded in 2019. Households began to increase then money holdings sharply again in October 2020, even though the second lockdown did not come into effect until 5 November 2020. In the last three months, UK households increases their money holdings by £13bn, £18bn and £21bn (£52bn in total), 3-4x the average monthly flows in 2019 (see chart above).

**Monthly flows of HH deposits in the EA** (Source: ECB; CMMP)

Similar household behaviour was seen in the euro area albeit with slightly different timings and scale. In the early stage of the pandemic, household deposits increased by €78bn and €75bn in March and April 2020 respectively, more than double the average 2019 monthly flows. In November and December 2020, monthly flows increased again to €61bn and €53bn (see chart above).

The challenge for inflation hawks here is that money sitting idly in savings accounts contributes to neither GDP nor inflation.

**Growth in private sector credit minus growth in money supply in the UK and EA** (Source: BoE; ECB; CMMP)

Analysis of the counterparts of monetary aggregate highlights the extent to which money and credit cycles are diverging in both regions. As noted last month, in typical cycles, monetary aggregates and their key counterparts move together. Money supply indicates how much money is available for use by the private sector. Private sector credit indicates how much the private sector is borrowing.

At the end of 2019, the gap between the growth in lending and the growth in money supply was 0.6ppt and -2ppt in the UK and EA respectively. By the end of 2020, these gaps had widened to record levels of -9.9pt and -7.6ppt (see chart above). Simply put, credit demand has remained relatively subdued in both regions, despite the low cost of borrowing, while money supply has accelerated.

**Trends in NFC credit, mortgages and consumer credit since 2018** (Source: BoE; ECB; CMMP)

Within subdued overall levels of private sector credit demand, relatively robust NFC credit and resilient mortgage demand offset weakness in consumer credit during 2020 in both regions (see chart above). The YoY growth in NFC credit in the UK increased from 3.3% in 2019 to 7.7% in 2020. Similarly, the respective growth rates in the EA increased from 3.2% in 2019 to 7.0% in 2020. Mortgage growth in the UK moderated slightly from 3.4% in 2019 to 3.0% in 2020 but rose from 3.9% in 2019 to 4.7% in 2020 in the EA. Consumer credit grew 6.1% and 6.0% in the UK and EA in 2019 respectively, but fell 7.5% and 1.6% in 2020 respectively.

**2020 monthly trends in HH consumer credit in the UK** (Source: BoE; CMMP)

**2020 monthly trends in HH consumer credit in the EA** (Source: ECB; CMMP)

The weakness in consumer credit was more significant in the UK than in the EA. Net repayments of £17bn made 2020 the weakest year for consumer credit on record. UK households repaid consumer credit in the last four months of 2020 and the annual growth rate of minus 7.5% represented the weakest rate of growth since the series began in 1994 (see first of the charts above). EA households also repaid consumer credit in three of the last four months of 2020, but the YoY decline of minus 1.6% was more moderate than in the UK.

Conclusion and three charts to watch in 2021

A sustained upturn in inflation and outperformance from cyclical and value sectors and shorter duration trades will require confidence, consumption and investment to return fully. There are three key signals to look for in the messages from the UK and EA money sectors in 2021.

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

First a moderation in monthly deposit flows, especially by the household sector, and slower growth in narrow money (M1) and hence broad money (M3).

**The yawing gap between money supply and private sector credit demand** (Source: BoE; ECB; CMMP)

Second, a re-synching of money and credit cycles with a corresponding rebalancing in the counterparts of broad money growth.

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

Third, and finally, a recovery in consumer credit. Consumer credit represents one section of COCO-based lending (see “Fuelling the FIRE”). Its supports productive enterprises since it drives demand for goods and services, hence helping NFCs to generate sales, profits and wages.

The relative scale in the shift of money holdings and weakness in consumer credit suggests that the UK has a higher gearing than the EA to a reversal of 2020’s COVID-19 induced dynamics. Watch this space in 2021…

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

“Bouncing back”

Relative cheer from UK mortgages

The key chart

**Positive volume trends (outstanding balances, monthly flows, YoY growth) for UK mortages in 4Q2020** (Source: BoE; CMMP)

The key message

UK mortgages provide some relative cheer among otherwise downbeat messages from the money sector:

Individuals borrowed £5.6bn in the form of mortgages in December 2020, unchanged from November, while repaying £1.0bn in consumer credit.
Quarterly flows (£15.9bn) in 4Q2020 were the highest since 1Q2008.
Despite this strong recovery, mortgage borrowing in 2020 (£43.3bn) was lower than in 2019 (£48.1bn) and current demand remains subdued in relation to previous cycles.
Looking forward, mortgage approvals (103,400) were the second highest since August 2007, and suggest positive future volume trends.
The effective interest rate on new mortgages rose 7bp in December to 1.9%, the highest rate since October and the spread between this and the rate on the outstanding stock narrowed to 22bp, from 55bp in February 2020.

Among mortgage providers, the sector winners are not simply riding these trends but are also increasingly embracing digitalisation across operations, sales, finance and risk management to differentiate themselves and improve the experience for their members.

The six charts that matter

**Monthly flows in UK retail lending (£bn) for 2020** (Source: BoE; CMMP)

The UK mortgage market continues to provide some relative cheer among otherwise downbeat messages from the money sector (see chart above). Individuals borrowed an additional £5.6bn in the form of mortgages in December 2020, broadly unchanged from November. In contrast, households repaid £1.0bn in consumer credit, having repaid £1.5bn, £0.6bn and £0.8bn in the three preceding months.

**UK mortgage volumes “bounced back” strongly from 2Q low** (Source: BoE; CMMP)

Quarterly mortgage flows totalled £15.9bn in 4Q20 compared with £11.1b, £3.8bn and £12.5bn in the three preceding quarters respectively. As can be seen in the chart above, this was the largest quarterly flow in the past five years and the largest since 1Q2008.

**But real growth remains subdued in relation to past cycles** (Source: BoE; CMMP)

Despite this strong recovery, however, total 2020 mortgage borrowing of £43.3bn was below 2019’s total of £48.1bn. Current mortgage demand also remains subdued in relation to past cycles (see chart above). In real terms, the 3-month MVA for mortgage demand was only 2.3% in December 2020, essentially stable real growth over the 2H2020

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

.Looking forward and more positively, mortgage approvals, which have proved a reliable indicator of future lending, were 103,400 in December, the second highest level since August 2007 (see chart above), and totalled 818,500 in 2020, the largest yearly number since 2007.

Effective interest rates on new mortgages and on the outstanding stock (Source: BoE; CMMP)

The effective interest rate on new mortgages rose 7bp in December to 1.9%, the highest rate since October 2019 (see chart above). This rate remains below the rate on the outstanding stock of mortgages (2.12%) but the spread between the two effective rates has narrowed to 22bp from 55bp in February 2020 (see chart below).

**Downward pressure on NIMs starting to ease?** (Source: BoE; CMMP)

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

“Out-of-synch”

What are the implications of the widening divergence between money and credit cycles?

The key chart

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

The key message

Current money cycles in the EA and UK, (1) differ from previous cycles in terms of their drivers and implications, (2) are out-of-synch with the respective credit cycles, and (3) diverging from credit cycles at historically rapid rates. The implications here for growth, inflation, policy choices, investment returns and asset allocation are missing from many recent “2021 Investment Outlooks”.

Is it wise to ignore the “messages from the money sector”?

This week’s data releases show broad money growing at the fastest rate in the current money cycle in both the EA (11.0%) and the UK (13.9%). What is this telling us?

For some, rising money supply suggests higher inflation in the EA and the UK and supports asset allocation shifts towards cyclical and value plays and shorter duration trades. The message from the money sector with elevated uncertainty, low confidence, weak consumption and subdued credit demand is, “not so fast.”

The charts that matter

**Growth trends in EA and UK broad money aggregates in % YoY** (Source: ECB; Bank of England; CMMP analysis)

This week’s ECB and Bank of England data releases show broad money growing at the fastest rate in the current money cycle in both the EA and the UK (see chart above). M3 in the EA grew 11.0% YoY in November 2020, up from 10.5% in October. M4ex in the UK grew 13.9% YoY in November 2020, up from 13.2%.

To understand what these trends are telling us, and to understand how the current money cycle differs from previous cycles, we need to examine both the components and counterparts to broad money rather than focus simply on the headline numbers.

**Growth in M3 (% YoY) and contribution of M1 (ppt) to total growth** (Source: ECB; CMMP analysis)

From a components perspective, we can see that growth in narrow money i.e. notes and coins in circulation and, more importantly, overnight deposits is the key driver of overall money growth (see chart above). In the EA, for example, M1 grew at 14.5% YoY and contributed 9.9ppt to the 11.0% YoY growth in M3. Overnight deposits grew 15.0% YoY and contributed 8.9ppt to the total growth alone.

**Share of narrow money (M1) in broad money (M3) since 2000** (Source: ECB; Bank of England; CMMP analysis)

Recent trends are an extension/acceleration of longer-term secular shifts in the composition of EA and UK money supply (see chart above). Twenty years ago, M1 accounted for 42% and 48% of M3 in the EA and UK respectively. The shares were the same at the height of the GFC in 2008. Today, however, M1 accounts for 71% and 68% of M3 in the EA and the UK respectively. This increase in liquidity preference/money holdings reflects an increasingly lower opportunity cost of holding money as rates have fallen and, more recently, a sharp rise in both forced and precautionary savings by the regions’ households.

**Trends in monthly HH deposit flows 2019-2020 YTD** (Source: ECB; CMMP analysis)

Households are increasing their money holdings at 2-4x the average 2019 monthly rate, delaying consumption and repaying existing consumer credit with negative implications for economic growth and inflation. In the EA, household money holdings increased by EUR61bn in November, almost double the average flow of EUR33bn recorded during 2019 (see chart above). This reflects similar, albeit more volatile, trends in the UK highlighted in, “And now, the not-so-good-news” and to repeat the message in that post – money sitting in savings accounts does not contribute to GDP or higher inflation.

**Trends in monthly consumer credit flows and YoY growth rate** (Source: ECB; Bank of England)

EA households are not only delaying consumption, they are also repaying existing consumer credit. In November 2020, net repayments totalled EUR4bn, the largest amount since the peak of the first wave of the pandemic in April. On a YoY basis, consumer credit declined by 1.1%, the weakest level in the current slowdown (see chart above). In the UK, households repaid consumer credit for three consecutive months between September and November 2020 and YoY declines are the weakest since records began.

**Repeating the key chart – the widening gap between growth in lending and growth in money supply** *(Source: ECB; Bank of England; CMMP analysis)*

In terms of policy choices, monetary policy effectiveness requires stable relationships between monetary aggregates, but these are increasingly absent. The gap between growth rates in money supply and private sector credit demand is at record highs in both regions. In the EA, the gap between the supply of money (11.0%) and private sector demand for credit (4.7%) was 6.3ppt. In the UK, money supply grew 13.9%, 9.4ppt faster than private sector credit demand. This is one more reason to add to a lengthening list of why the required and sustained policy response should be, “fiscal, first and foremost.” In my next post, I will up-date my analysis to add another factor to this list i.e. credit is increasingly shifting towards less productive sectors of the economy (see also “Fuelling the FIRE – the hidden risk in QE“).

**A preview of the theme in my next post – COCO-based versus FIRE-based lending** (Source: ECB; CMMP analysis)

Conclusion

**What does this all mean?** (Source: ECB; Bank of England; CMMP analysis)

For some, rising money supply suggest higher inflation in the EA and the UK, and supports asset allocation shifts towards cyclical and value plays and shorter duration trades. The message from the money sector remains, “not so fast.”

**One of my favourite current charts! Growth in M3 and contribution of M1 and PSC.** (Source: ECB; CMMP analysis)

CMMP analysis of the components and counterparts of broad money tell a very different story from previous money cycles. The EA and UK money sectors are consistent signalling elevated uncertainty, low confidence, weak consumption and subdued credit demand – even before the introduction of further, more stringent lock-down policies in January 2021.

If there is a positive interpretation of current trends, it is that there is a large element of forced savings and hence pent-up consumer demand. That is true, but history also tells us that households and corporates can take time to adjust to major economic shocks and caution us against expecting a rapid reversal in confidence and consumption.

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

“And now, the not-so-good-news”

Too early for UK inflation hawks to get excitied

The key chart

**Trends in UK M4ex – is this a different form of monetary expansion?** (Source: Bank of England, CMMP analysis)

“Money sitting idle in a savings account does not contribute to GDP”
Dirk H. Ehnts, Modern Monetary Theory and European Macroeconomics

The key message

UK money supply (M4ex) increased 13.9% YoY in November 2020. Does this mean that investors positioned for a pick-up in UK inflation should be getting excited?

No, not yet (if at all).

As mentioned in previous posts, the message from the money sector is very different now from previous periods of rising money supply. The key 2020-21 messages remain:

heightened household uncertainty
weak household consumption
subdued overall credit demand

None imply ST inflationary pressures.

Household uncertainty – the chart that matters

**Monthly flows in UK households sterling money holdings in £bn** (Source: Bank of England; CMMP analysis)

Household M4 accounts for 64% of total M4ex. In November 2020, UK households increased their sterling money holdings by £17.6bn, up from £9.4bn in October. This represents the second highest monthly flow after May 2020’s £25bn and was almost 4x the size of the average monthly flow in 2019. Uncertainty reigns in the UK household sector.

Weak household consumption – the chart that matters

**Monthly flows in UK consumer credit in £bn – a negative figure indicates net repayments** (Source: Bank of England; CMMP analysis)

Households also made net repayments in consumer credit for three consecutive months between September and November 2020 of £0.8bn, £0.7bn, and £1.5bn respectively. The -6.7% YoY decline in consumer credit in November was the weakest level since the series began in 1994.

Subdued credit demand – the charts that matter

**YoY growth rates in the BoE’s headline money (M4) and credit (M4 Lending) series – out of synch!** (Source: Bank of England; CMMP analysis)

**YoY growth rate in lending minus YoY growth rate in money – abnormal money and credit cycles** (Source: Bank of England; CMMP analysis)

Finally, the gap between growth in M4 (13.9%) and ML lending (4.5%) remains at a record high of 9.4ppt. In other words, this is not a normal cycle with synchronised money and credit trends (albeit with traditional leading and lagging relationships). Consequently, and with credit demand remaining subdued, investors should be wary of assuming normal relationships between money supply and inflation (to the extent that such relationships exist at all).

Conclusion

“Monetary policy effectiveness is based on certain stable relationships between monetary aggregates.”
Richard Koo, The Holy Grail of Macroeconomics

To repeat the penultimate lesson from the money sector in 2020 – periods of monetary expansion differ in terms of their drivers and implications. The message in the pre-GFC period was one of over-confidence and excess credit demand. In contrast, the current message is one of elevated uncertainty, weak consumer demand and subdued overall credit demand (with the added uncertainty regarding the extent to which rising savings are forced or precautionary).

It is too early for UK investors who are positioned for a pick-up in inflations to get excited.

[Note that this post was drafted before the announcement of further UK lockdown restrictions on 4 January 2020]

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

“First, some good news”

Positive trends for UK mortgage providers

The key chart

**Trends in UK mortgages during 2020 -balances, monthly flow and YoY growth rates** (Source: Bank of England, CMMP analysis))

The key message

The Bank of England’s latest “Money and Credit” release (4 January 2021) provides three positive data points for UK mortgage providers. First, households borrowed £5.7bn secured on their homes in November 2020, the highest level since March 2016. Second, mortgage approvals are at their highest level (105,000) since August 2017, suggesting positive future lending trends. Third, the effective rate on new mortgages increased a further 5bp in November to 1.83%, up from August’s low of 1.72%.

That said, mortgage demand remains very subdued in relation to historic trends and rates on new lending continue to act as a drag on revenues generated from outstanding mortgage balances.

As noted, back in October and December 2020, this is no time for mortgage providers to relax despite these positive developments. The winners in 2021 and beyond will be those providers who accelerate digitalisation across operations, sales and finance and risk to differentiate themselves and improve the experience for their members.

Six charts that matter

**Worth repeating the key chart again!** (Source: Bank of England; CMMP analysis)

UK households borrowed £5.7bn secured on their homes in November 2020, the highest level of monthly borrowing since March 2016. November’s monthly flow compares with average monthly borrowings of £4bn in 2019 and £2.7bn in 1H2020. The YoY growth rate in mortgages rebounded slightly to 2.9%, above the recent lows of 2.7% YoY recorded in August and October 2020.

**Looking forward – trends in approvals for house purchases since 2007** (Source: Bank of England; CMMP analysis)

Mortgage approvals in November – an indicator for future lending – hit the highest level since August 2007. Approvals for house purchases increased to 105,000 from 98,300 in October and the 2020 low of 9,349 in May. In its commentary, the Bank of England noted that, “recent strength in approvals has almost fully offset the significant weakness earlier in the year.”

**Trends in the effective rate on new mortgages** (Source: Bank of England; CMMP analysis)

The effective rate on new mortgages (the actual interest rate paid) increased a further 5bp in November to 1.83%, up from August’s low of 1.72%. This rate is, however, still down 4bp YoY and 5bp YTD. The rate on the outstanding stock of mortgages was slightly lower at 2.11% in November (a new low).

**Monthly flows (£bn) in lending to UK individuals** (Source: Bank of England, CMMP analysis)

Resilient mortgage demand is the one bright spot in an otherwise gloomy UK retail lending market. Total lending to individuals grew by only 1.6% YoY, despite the 2.9% growth in mortgage lending. The annual growth rate in consumer credit fell to -6.7% in November, another series low. Since the beginning of March, UK consumers have repaid over £17bn in consumer credit.

**UK mortgage lending since 2000** (Source: Bank of England; CMMP analysis)

That said, current mortgage demand remains very subdued in relation to past cycles (see graph above). Real YoY growth rate in mortgage has averaged only 2.2% YoY during 2020. This compares with an average real growth rate in excess of 9% YoY between November 2000 and November 2008.

**Effective interest rates on new mortgages and the outstanding stock** (Source: Bank of England; CMMP analysis)

The 28bp gap between the effective rate on new mortgage lending (1.83%) and the effective rate on the outstanding stock of mortgages (2.11%) is relatively narrow in relation to recent trends but on-going pressure on NIMs and revenue growth remains a key challenge for the sector.

Conclusion

As noted, back in October and December 2020, however, this is no time for mortgage providers to relax despite the positive developments noted above. The winners in 2021 and beyond will be those providers who accelerate digitalisation across operations, sales and finance and risk to differentiate themselves and improve the experience for their members.

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