Eurozone M3 data are out…
That’s the annual growth rate of the euro-zone broad money supply (M3) falling from 3.1 per cent to a well below expectations 2.6 per cent in March and allowing a quick segue into a good news/ bad news post ahead of next week’s ECB meeting and increasingly probable cut.
From Deutsche’s Mark Wall with our emphasis:
Assets (Credit): Good
The good news is that the flow of credit to the real economy shows slow rehabilitation. Before adjusting for securitization, the flow of loans to the real economy was positive for the first time in 11 months. Lending to corporates is being dominated by short-term loans (less than one year). This is consistent with the message from the Bank Lending Survey that corporate demand for credit for inventory and working capital was rising in Q1 for the rise time in 6 quarters. The latest PMI data suggests restocking tailwinds could lose some vigor in Q2, but the credit news is nevertheless encouraging. Historically, growth in the shortest duration loans has led the recovery in credit expansion in longer duration loans. Technically, in March the euro area credit impulse held onto the gains it made in 2012.
Liabilities (Deposits): Bad
The concerning issue is how the duration of the liabilities on the euro area banking sector balance sheet continue to shorten. M3 growth decelerated from 3.1% yoy to 2.6% yoy due to marketable instruments, that is, the least liquid part of M3. The flow into overnight deposits remains positive, with annual growth now at 8.2%. Despite the impact OMT has had on financial market confidence, money holding sectors continue to pull out of bank liabilities with duration. The outstanding volume of short-term bank bonds (less than 2 years) saw a further E16bn outflow in March (E75bn over the last year). Longer term bank bonds (more than 2 years) saw E38bn of outflows (E118bn over the last year). For sure, 3Y LTROs are displacing these liabilities, but with a flat yield curve and prevailing crisis uncertainties, money holders are keeping their liquidity strictly short-term and accessible. The trouble is that short duration liabilities (overnight plus short-term deposits) are a rapidly rising portion of total liabilities and the LTROs themselves are getting shorter and are being repaid. This opens a maturity mismatch risk between bank liabilities and assets. The mismatch may compromise the ability of the banking system to extend longer-term credit. Unless an inventory cycle drives a general economic recovery and banks become more confident and take the maturity transformation risk, this mismatch problem could constrain the credit — and economic — recovery. If this problem lingers, it could put the onus back on the ECB to take maturity risk, for example, through even longer term LTROs. The ECB may cut policy rates next week, but the pressure for non-standard policy is not abating. In fact, a rate cut, by flattening the curve, could reinforce the liability problem.
Other positives
There are two other positives in the latest M3/credit report. First, the flow on banks’ net external assets was positive again in March. This continues to signal a steady re-flow of funds back into the euro area, a sign of confidence in the single currency. Second, banks in the crisis peripherals continue to see a rebuilding of private sector deposits, with Italy and Spain reporting large inflows in March (E46bn and E16bn respectively). There is no obvious sign of Cyprus-related deposit flight from the vulnerable banking systems.
And a chart-gasm from Capital Economics (which you can click to enlarge):
Anyway, summary and successful Cypriot capital controls aside it’s fairly interesting that the euro barely moved on the release. A refi-rate cut at Thursday’s ECB meeting priced in now? Just about everybody in out inbox thinks yes even if Wall thinks it might exacerbate the liability problem.
However, as SocGen argued, a cut in the main refinancing rate would largely be ineffective as short-term interbank rates are already close to zero and markets are fragmented — as the FT noted, Spanish and Italian companies are not able to benefit from the same financing conditions, particularly in the small and medium-sized enterprise (SME) sector. A cut would serve to cap a rise in Eonia as excess liquidity continues to fall but bar that it’d be more of a signal at this stage.
‘Signalling what?’ is the obvious question. There are non-standard measures that might be brought to bear such as a deposit cut into negative territory (nah) further easing of collateral requirements, more LTROs (how about a new LTRO done on collateralised SME loans?) or some forward guidance but we are unlikely to get that next week.
The ECB tends to take its time on these things particularly when the moral hazard argument hands so heavy in the air. From SocGen again to close:
2. Recent ECB speak has mainly focused on problems related to financial fragmentation in Europe. In fact, Mr. Draghi has gone to great lengths to describe the current monetary policy stance as already very accommodative (with full allotment of liquidity at fixed rates for “as long as necessary”), while also stating that consensus at the last meeting was “not to look at rates for the time being”;
3. ECB action could dilute pressure on governments to act, both in terms of growth-enhancing structural reform and progress with the Banking Union. The Cyprus events exemplified the need for progress with Banking Union in Europe and the ECB has been clear that the ECB cannot compensate for the lack of action by governments to address weak underlying growth; and
4. We also see risks for banks’ and money markets profit margins to be squeezed by low policy interest rates. For example, in many countries (Spain and Ireland come to mind), tracker mortgage rates linked to market rates would likely decline if the ECB were to cut rates. This could reduce banks’ revenues and possibly profit margins (while benefitting mortgage clients). This may be particularly worrisome for smaller and peripheral banks as it could potentially reduce incentives to lend.
Related links:
What inflation? FT Alphaville
Fragmentation and rebalancing in the euro area – ECB
Mmm Mmm Mmm Mmm – Crash Test Dummies