This morning the economic news has simply flowed on from what we looked at on Friday. So a -0.4% GDP growth rate for Germany has been followed by this announcement from the ECB just now.
Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, decreased to -0.7% in January from 0.6% in December.
Actually the order of events is the other way around as it is changes in the money supply which lead economic events, and in the case of a narrow money measure around 3/6 months ahead. A year ago the annual growth rate was 9.1% as we see quite a change in policy, and the number has been galling since the post pandemic peak above 16%.
As we have been observing the monthly numbers have been falling for some months now and the latest numbers are -100 billion Euros for November, -113 billion for December and -89 billion for January. Last month on the 27th I pointed out that the M1 money supply had declined by 148 billion Euros in October and added this.
So we are seeing quite a hard contraction.
So we see that prospects are not good for the beginning of 2023 for the Euro area. This adds to a fourth quarter of 2022 where if we take out the distorting effects of Ireland the Euro area economy was at best flatlining and in fact probably contracted slightly.
Interest-Rate Rises
As the ECB does not pursue explicit reduction of the money supply these days ( no monetary targets) much of what is taking place here is a response to the increases on interest-rates which began on the 27th of July last year with a 0.5% increase to 0% for the Deposit Facility. Also markets had been making their own move whilst the ECB dithered and delayed.
Bank funding costs have risen in recent months, which has increasingly fed into higher bank lending rates, in particular for households. ( President Lagarde)
That is ominous for prospects as it has already raised to 2.5% this year and guided us towards it being 3% next month.
Actually President Lagarde pretty much admitted this in an interview with the Economic Times of India on Friday.
Hiking rates inevitably dampens demand. And what we’re trying to do is to adjust demand. That’s the mechanical impact that we expect from what we are doing.
So means general demand but it works also for the money supply and whilst we are discussing her interview she was as confused as ever.First offering guidance.
There is every reason to believe that we will do another 50 basis points in March.
But then
We are data dependent.
Markets have shifted recently as I pointed out last Wednesday referring to higher bond yields.
TRADERS PUSH BACK PEAK ECB RATE BETS INTO 2024 FOR THE FIRST TIME. ( @financialjuice)
Broad Money
This matters as it looks more like 18 months or so ahead and the feeds into nominal GDP.
Annual growth rate of broad monetary aggregate M3 decreased to 3.5% in January 2023 from 4.1% in December.
This is a problem because if there is inflation then there is little room for economic growth.Indeed an inflation rate of 3.5% so much lower than now would suggest 0% GDP growth in real terms. But there is more to come if we look ahead.
The annual growth rate of short-term deposits other than overnight deposits (M2-M1) increased to 15.1% in January from 14.0% in December. The annual growth rate of marketable instruments (M3-M2) increased to 13.3% in January from 11.3% in December.
The wider components of the M3 measure are in fact growing quickly which tells us that it is the narrow measure pulling the numbers lower. As pressure there looks set to be sustained with another interest-rate rise next month then should the wider numbers weaken things will get worse. Actually the widest part ( M3 – M2) has already fallen from 48 billion Euros in November to only 1 billion in January suggesting a fall this month and thus another brake on M3 growth.
So a decline in the annual growth rate below 3% looks baked in and a likely fall to 2%. This provides a problem because if we look back to around 2014 we see that these are the sort of money supply growth levels that led to large-scale QE bond purchases and negative interest-rates.
QE
This has started to become a real problem for the ECB and let us for the moment stay with the money supply issue.
As communicated in December, the APP portfolio will decline by €15 billion per month on average from the beginning of March until the end of June 2023, and the subsequent pace of portfolio reduction will be determined over time.
So from next month some 15 billion Euros of liquiidity will be withdrawn further depleting the money supply. We have learnt from the bond buying days it may not be immediately picked up by the numbers but it is yet another brake on them that will be along.
If we now return to the my previous point it looks as though the ECB will be reducing QE at levels of money supply growth that made it introduce it! Make of that what you will.
Balance Sheet Losses
The main reason for the above came from the annual accounts released on the 23rd of this month.
ECB profit zero in 2022 (2021: €0.2 billion) after release of €1.6 billion from provision for financial risks
No profit distribution to euro area national central banks.
So a 1.8 billion Euro decline on the previous year which will be much worse this year.
These changes resulted from increases in the interest rate on the Eurosystem’s main refinancing operations to levels above 0% since 27 July 2022.
So the interest-rate rises only began in July and it is much higher now and the issue comes from a source which raises a wry smile.
the interest expense resulting from the ECB’s net TARGET2 liability, which amounted to €2,075 million (2021: €22 million interest income).
There have been so many official and media denials of any potential issues with TARGET2. Although this one is different to any national problem as it has been self-inflicted via the interest-rate rises. Indeed it is ECB policy to make it worse.
The era of profits is over as the ECB now faces other consequences of its actions.
Write-downs amounted to €1,840 million (2021: €133 million), mainly stemming from unrealised price losses on securities held in the own funds and US dollar portfolios owing to increased bond yields.
Let me also point out this number as it may confuse. The ECB usually holds 18% of things like QE and passes 82% to the national central banks so its “own” balance sheet is reduced.
The total size of the ECB’s Balance Sheet increased by €19 billion to €699 billion (2021: €680 billion).
Oh and if they have booked profits on the pension schemes then surely that will look (much) worse this year.
Total staff costs decreased to €652 million (2021: €674 million), mainly as a result of actuarial valuation gains relating to other long-term benefits.
Don’t forget the pay rises due rather awkwardly to the inflation that ECB President Lagarde dismissed as a “hump” early last year.
Comment
The simple reality is that money supply growth is negative for both narrow and broad money and narrow money is now falling in annual terms. So a brake is being applied to an already weak economy and it will impact up until late 2024. There is an especial irony as we have seen improvements in the trend for energy prices which on their own would boost the economy.
If we step back we see that the ECB boosted the economy when inflation pressure was building and now is applying a brake when it is weak.Those were exactly the reasons the job was taken away from politicians and given to technocrats. The Euro area establishment forgot that when they gave the job back to a politician in Christine Lagarde.
Next up will be all the money being paid to banks on reserves created as a result of all the QE bond buying. The Precious! The Precious!
No doubt it will be a case of bonuses all round….