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!
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.