The European Central Bank is currently “pushing on a string” in a liquidity trap

The last 24 hours has given an opportunity to compare the monetary situation of the Euro area with that of the UK. On the one hand one might expect the results to be similar as both had at the time of the data an official interest-rate of 0.5%. But in an era of extraordinary measures we also get to see the impact of a the shrinking of the balance sheet of the European Central Bank. This contrasts with the stability of the Bank of England balance sheet which in an example of what Sir Humphrey Appleby would have called masterly inaction remained around £403/4 billion this summer and autumn.

Euro area money supply

The news on this was yet again a disappointment.

The annual growth rate of the broad monetary aggregate M3 decreased to 1.4% in October 2013, from 2.0% in September 2013.1 The three-month average of the annual growth rates of M3 in the period from August 2013 to October 2013 decreased to 1.9%, from 2.2% in the period from July 2013 to September 2013.

As you can see the rate of growth is declining and if we project that forwards we will have concerns for the Euro area economy as we move through the spring and summer of 2014. This is not inspiring when it is supposed to be recovering and growing after the recession which has just ended.

If we look to the amount of credit being advanced an even grimmer picture emerges from the gloom.

 the annual growth rate of total credit granted to euro area residents was more negative at -1.0% in October 2013, from -0.8% in the previous month.

Actually Euro area banks were lending to governments so the picture for the private-sector was even worse.

Among the components of credit to the private sector, the annual growth rate of loans stood at -2.1% in October, compared with -2.0% in the previous month………The annual growth rate of loans to non-financial corporations stood at -3.7% in October, compared with -3.6% in the previous month.

As you can see the picture gets worse as we progress because it is lending to businesses which is in the worst state of all. On this road (to nowhere) we see the rationale for the interest-rate cut made by the ECB earlier this month.

A Liquidity Trap

This is a theoretical concept in economics where monetary policy loses effectiveness. Actually it is mostly defined in terms of interest-rates when they approach zero. But the reality of the credit crunch is wider than that as other monetary measures are lauded and praised but the truth is that their effectiveness has disappointed too.

Another phrase for this situation was called “pushing on a string”. If we look to analyse that we can take a look at what is called narrow money as the ECB can “push” on that.

the annual growth rate of M1 stood at 6.6% in October 2013, compared with 6.7% in September.

As you can see the ECB has been pushing hard but even there the effect may be fading. Now let me add a nuance as you can regard a narrow money measure such as M1 as a money supply but a wider one such as M3 is much more a measure of money demand. So if we take a sweping simplification we see that the ECB is supplying money that the economy does not want. If we nail that down we see that the main area where there is not “demand” is exactly where the ECB would like to see lending, the business sector.

Let me be clear about the demand bit. I do not mean that businesses do not want finance I mean that there is a combination of this.

1. It is not be offered at all to some businesses

2. Banks are not offering finance to firms on terms they are will to accept.

Point two has various nuances as businesses may not like the interest-rate or it may be terms like having to put up their house as surety. Actually in the part of Europe where I believe that this most applies we could use the word villa rather than house.

So the “push” of the ECB is being lost in the financial intermediation of the banking sector which takes the liquidity it provides and seems to prefer at least in the southern periphery to invest the money in government bonds than to actually lend it out as hoped.

A policy error

It is easy to blame the banks but the ECB has to turn the mirror on itself too. It has imposed a risk measurement system where government bonds in the Euro area have a rsk weighting of zero. Apart from being obviously wrong (Greece has had a default and will be joined by others in my opinion) it tempts banks to invest in something “risk-free”. This is exacerbated by the fact that banks are under capital pressure with new stress tests approaching so they are pushed towards “risk-free” sovereign bonds as opposed to risky business lending. In fact business lending is usually regarded in capital terms as very risky. So if you were setting up a structure to cut business lending you actually might have imposed what is taking place right now.

Of course at the height of the Euro area crisis it was convenient for the ECB to nudge banks into investing in sovereugn bonds as it helped reduce yields but now it is clear that this diverted funds away from more productive areas.

This policy mistake is in fact generally true of the Basel regulations and the Bank of England has ploughed the same furrow where monetary policy is expansionary but financial/regulatory policy is contractionary. Perhaps Stealers Wheel were prescient about the individuals responsible for this.

Clowns to left of me
Jokers to the right

Actually I find that in the media the people responsible for such decisions are usually described as “respected” although we virtually never find out by whom!

The Euro

I have written many times about the rise of the value of the Euro on the foreign exchanges. It has pushed above 1.36 this morning versus the US Dollar and is undergoing quite a surge against the Yen and only just failed to hit 140 Yen overnight. So just as there are problems elsewhere the “external” monetary situation is tightening on the Euro area too.

The Bank of England

The UK’s current mini-boom hides thet fact that the UK’s situation is less different to that of the Euro area than we in the UK might like to think. We are mananging a higher rate of broad monetary growth at least on the Bank of England’s preferred measure (the other numbers are weaker).

The three-month annualised and twelve-month growth rates were 4.5% and 4.4% respectively.

But bank lending is weaker than that.

The three-month annualised and twelve-month growth rates were 1.8% and 0.0% respectively.

Indeed if we look into the detail we see some familiar issues here.

Loans (including overdrafts) to non-financial businesses decreased by £1.1 billion in October, compared to the average monthly decrease of £1.3 billion over the previous six months. The twelve-month growth rate was -3.3%.

Within this, loans (including overdrafts) to small and medium-sized enterprises (SMEs) decreased by £0.5 billion, in line with the average monthly decrease over the previous six months. The twelve-month growth rate was -3.1%.

So actually some of the themes are the same and if we add in the fact that the value of the pound has risen by 5% since Mark Carney introduced his policy of Forward Guidance we may be getting a bit of deja vu. However there is a difference.

Total lending to individuals increased by £1.7 billion in October….. The three-month annualised and twelve-month growth rates were 1.6% and 1.2% respectively.

And I guess that readers will not be falling off their seats when we see the breakdown of this.

Lending secured on dwellings increased by £1.2 billion in October…… The three-month annualised and twelve-month growth rates were 1.1% and 0.8% respectively.

Also it looks as though there is more to come.

The number of loan approvals for house purchase was 67,701 in October, compared to the average of 60,685 over the previous six months.

Actually consumer credit is currently the strongest component.

The three-month annualised and twelve-month growth rates were 6.0% and 4.7% respectively.

This does seem to have impacted on the real economy if we think of the UK car market which seems to have been boosted by the availability of finance in 2013.


The problem for the ECB is that the current monetary conditions are flashing an amber light for future developments. This raises all sorts of fears that it may continue to dip in and out of recession or worse in 2014/15. As to the effectiveness of its recent rate cut let me quote the little girl Newt from the film Aliens.

It won’t make any difference

So what governing board members of the ECB would like for Chrismas is not the apochryphal two front teeth but a plan to get them out of the current quagmire. As if their public pronouncements are any guide they do not have one.

Also whilst the current mini-boom makes the UK look different right now there are more similarities to the Euro area situation that we would like. Especially if we start to wonder how much of the rising money supply is funds arriving from abroad. It is for that reason that I replied in the comments section yesterday that a base rate cut and rise are in my opinion about equal in probability for the next move.



This entry was posted in Bank of England, Euro zone Crisis, European Central Bank, General Economics, Quantitative Easing and Extraordinary Monetary Measures, UK Inflation Prospects and Issues and tagged , , , , , . Bookmark the permalink.
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  • Anonymous

    Hi Shaun,

    I think you understate the case on Southern European banks. They want the right to seize anything you own, they renege on multi-year loan agreements and demand instant repayment They charge interest rates over 15% on euro denominated loans. Small wonder that nobody wants to borrow from them.

    UK banks have upped fees for overseas cash machine withdrawals – stealth fees. But on a positive note, this week I discovered – International exchange by bank transfer at low cost. Nice to see the banks facing real competition.

  • ernie

    Hi Shaun,
    As you said in the blog, the effective situation is that high and continuing public sector borrowing (eg Spain) is crowding out private sector lending. It is also a fact that business conditions are such that the demand for credit is low anyway, and this is especially so if lending conditions are such as outlined by ExpatinBG. The other big thing is – what has been the real impact on bank deposits of the Cyrpus bail-in? Do you have any useful figures of deposit movements since the end of March? I had understood the ECB had become really coy about publishing these figures? Given the bad loans held everywhere plus the lack of deposits, I would suggest many of the eurozone banks are not really able to lend anyway. They prefer to continue with the interest profit on their “risk-free” lending using the ECB’s “three-card trick” system whereby they can lodge their domestic government bonds at the ECB.

  • Justathought

    Hi Shaun,

    Slowly we are reaching the time for the New Year’s resolutions… We already know the ECB one…”Whatever it takes” and the BoE one…”Re-election”…So nothing new under the skies…The well engaged decline will be pursued with alternative rapid and slow move periods…(1870-1896 all over again). In the meantime some desperate individuals might take drastic actions (Suicides are increasing day by day) or if I believe the news that some folks in Greece are getting infected by HIV voluntarily in order to get a monthly allowance of 700 Euro plus free medical attention. In Belgium they removed 52.000 unemployed workers from the “dole” and transferred them into another social category. (It looks better to claim a lower rate of unemployment)…So manipulation of data will carry on with vengeance…

    And if I believe the attached document, we are far from been out of the woods…

  • Rods

    Hi Shaun,

    Another interesting blog.

    I think Europe has much further to go than the US and to a lesser extent UK in sorting out its banks. The UK is not out of the woods yet, but is much further through the process of identifying and selling on or writing off bad debts. It looks like the Basel capital requirements are going to be counter-cyclic for sometime yet.

    “1. It is not be offered at all to some businesses

    2. Banks are not offering finance to firms on terms they are will to accept.”

    I think there is also a third reason, lack of demand means that businesses don’t need or want to borrow money to expand their businesses.

    The UK is finally growing but much of the credit expansion seems to be in the housing market and an increase in unsecured consumer debt. With falling real wages what could possibly go wrong?

    Abenomics to me seems to be the last throw of the dice from an addicted gambler hoping for a big payday to pay off their gambling debts, and we all know how this story normally ends!

    The US is addicted to a $85bn QE shot every month and when has feeding an addiction ever improved the patients quality of life?

    The problem for the Western World’s central banks is that everytime they go to the cupboard marked “emergency recovery tools” to try and get some economic growth in the words of old Mother Hubbard; “it was bare”.

    In all Western European countries without supply side reforms, lower taxes and regulation I can’t see how they are going to get an economic escape velocity where they have to compete globally.

    I see Capital Economics are now predicting that the UK will have removed its deficit in 5 years. It looks to me brave call when the world is still in the grip of an economic storm. What could go wrong? Events, dear boy, events.

  • OldAl

    Hi Shaun,
    Is it possible that the righting of past wrongs (PPI, Equitable Life,
    mis-sold swaps, mis-sold endowments, even BP Deepwater Horizon payouts) are acting like ‘helicopter money’ and getting the economies of the UK and USA moving a bit more than just increased borrowings? Perhaps there are similar opportunities in Europe, as yet unexplored?

  • Anonymous

    Not all banks are equal. Unicredit’s Bulgarian subsidiary is giving out mortgages, as opposed to OTP’s subsidiary who are frantically trying to reduce their loan book.

  • Anonymous

    Hi ExpatInBG

    I agree that conditions are worse in the periphery and we have another type of economic divergence. If we compared the price and other terms for business lending in Germany with that of Spain or Italy I am sure that it would be worse than the relative bond yields. Probably much worse…..

    With a common currency and interest-rates it was not supposed to be this way…

  • Anonymous

    Hi Ernie

    I can help about Cyprus and intriguingly the Central Bank of Cyprus numbers came up as needing a password! The ECB site is a little opaque but does confirm further falls which back up these numbers from the Cyprus Mail.

    “In October total deposits of non Monetary and Financial Institutions (MFIs) in banks stood at €47.312bn, a drop of €163m from September.”

    “From March to October, deposits dropped by a whopping €16.4bn. And from October 2012 to October 2013, total deposits shrank by 22.7 per cent.”

    So the Cypriot banking system remains under a lot of pressure which as you say explains this.

    “The total credit to non-banks in the system was 12.1 per cent lower compared to the same month (October) last year.”

  • Anonymous

    Hi Noo2

    There are various lists like this around although often they are the other way around with sometimes JP Morgan and Deutsche Bank heading the list which nobody wants to lead! What the numbers need is a full allowance for the derivative risk on the various books (a regular theme of mine) and perhaps also a number for how recent house price changes have changed things.

    But some themes do have substance in that the US and UK dealt with their banks earlier than Europe and that the French banks could easily see a reversal. For that reason alone it is not a surprise to see the French economy struggling.

  • Anonymous

    Hi Rods

    A few years back I was discussing matters on the FT markets live page and someone pointed out that he had made all his money by reversing their forecasts! It still raises a smile…More seriously this sort of things look okay now so lets do a Buzz Lightyear and project it to infinity thinking does economics a disservice I think.

    Next week in the autumn statement it will be reasonable to cut the deficit forecast for this fiscal year year and maybe assume a little momentum in to the next but that’s it.

    As to Abenomics many commentators raised a cheer that Japanese CPI rose to 1.1% but Mr and Mrs Watanabe will be rueing the increases in fuel light and electricity charges running at an annual rate of 5.7%. Apparently “economic success” involves getting poorer and generating a cost of living crisis! With the Yen slipping downwards again Japan is kind of following the Mervyn King strategy is it not?

  • Anonymous

    Hi OldAl

    I think that the is a strong case for the UK economy having been given a boost by the various miss-selling payouts. The last figure I saw on actual PPI payouts was that they had passed £10 billion in the last spring. So yes but with so many things happening at once it is impossible to specify the impact with any precision.

    You could say that there has been round-tripping from UK taxpayer bailouts and guarantees to banks who have made payouts to UK consumers.

    As to Europe there is scope in Spain for the miss-selling of bonds in the largest caja Bankia as described here.

    “Its troubles have caused widespread outrage in Spain as hundreds of thousands of small savers, often retired people with little or no knowledge of finance, lost their money by investing in the bank when it was floated or by buying complex debt products that it sold between 2007 and 2009.

    Many of those debt products are now being converted to shares as part of the latest restructuring designed to clean up its balance sheet.”

    However in Spain it is a little more awkward with the fiscal rules in place as to who will finance any payouts.

  • theyenguy

    Finviv Charts show that the UK, EWU, and UK Small Caps, EWUS, rose to new rally highs in financial market trading on Friday November 29, 2013. Their seigniorage, that is their moneyness, came from a 0.9% buy of the British Pound Sterling, FXB, and a 1.2% sell of the Japanese Yen, FXY, which fueled UK Financial Firms, such as Prudential, PUK, and, Lloyds Banking Group LYG, strongly higher. One of liberalism’s most terrifically inflated fiat investments is UK based Prudential Life Insurance, PUK, which has risen 450% in the last five years, it has always been a currency carry trade darling fueled by abundant credit liquidity like you refer to in your article.