The economic outlook for the Euro area looks even weaker

by Shaun Richards

Today brings the economy of the Euro area into focus and to my mind yesterday brought us something to consider so let me hand you over to Statistics Netherlands.

In January 2019, prices of owner-occupied dwellings (excluding new constructions) were on average 8.7 percent higher than in the same month last year. The price increase was somewhat higher than in December 2018. This is evident from price monitoring of existing owner-occupied dwellings by Statistics Netherlands (CBS) and The Netherlands’ Cadastre, Land Registry and Mapping Agency.

This is a very familiar theme as we find that the era of low and in this instance negative interest-rates and QE bond purchases leads to higher house prices. We have looked at house prices in the Netherlands regularly over the credit crunch era so let us remind ourselves of the full scope and the emphasis is mine.

House prices reached a record high in August 2008 and subsequently started to decline, reaching a low in June 2013. The trend has been upward since then. In May 2018, the price index of owner-occupied dwellings exceeded the record level of August 2008 for the first time. In January 2019, house prices reached the highest level ever.

Compared to the low in June 2013, house prices were up by almost 36 percent on average in January 2019, and 6.5 percent higher on average relative to the previous peak in August 2008.

There are various issues to consider here of which the first is simply timing. Different central banks responded in different ways to the credit crunch but house prices turning in the summer of 2013 is a rather familiar message. Also we note that the turn in house prices was driven by credit easing policies at this point as large-scale QE had not yet begun. From December 2011.

To conduct two longer-term refinancing operations (LTROs) with a maturity of 36 months and the option of early repayment after one year.

They amounted to around one trillion Euros and slowly we see in this instance the Netherlands housing market began to sing along with George Benson.

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Why do central bankers love this? A speech from Peter Praet of the ECB last week gave us the two main reasons and he opened with the wealth effects.

Residential real estate (RRE) is the main component of euro area household wealth. Housing accounts for around 50% of asset holdings[2] and is largely financed through borrowing, with mortgages making up 85% of household liabilities

Then the fact that it supports “the precious”.

The corollary is a tight linkage between RRE prices and the balance sheets of the euro area banking sector. Mortgage loans account for between 40% and 90% of total lending by euro area banks to households across EU countries.

One way of looking at the problems of the Italian is to note that the balance sheets of the banks have not been helped by higher house prices for their mortgage balance sheets and troublingly in fact it is getting worse.

According to preliminary estimates, in the third quarter of 2018 the House Price Index (see Italian IPAB) decreased by 0.8% compared with both the previous quarter and the same quarter of the previous year (on annual basis it was -0.4% in the second quarter).

The linkage to the real economy was also provided by Peter Praet and at the moment he will be thinking of the positives in spite of the fact he looked at it in reverse here.

Falls in prices therefore affect the euro area business cycle through two main channels. First, by reducing households’ net wealth, which has decelerator effects on consumption[3], and weakening banks’ balance sheets through the decline in collateral and property values (the asset valuation channel); and second, by increasing the riskiness of households and of construction firms, prompting banks to tighten their lending standards (the credit risk channel).

Overall I guess he will be happy with this.

House prices rose by 4.3% in both the euro area and the EU in the third quarter of 2018 compared with the same quarter of the previous year.

This compares to a current consumer inflation rate of the order of 2.1% back then which does not seem to include house prices, can anybody think why? Let me help out by suggesting in central banker terms at least the other around 2% is wealth effects.

Returning to the monetary analysis theme and looking at the path of narrow and broad money growth it looks as though house prices move with broad money growth which is logical with the role of mortgage lending in overall bank lending. House prices may even move first perhaps in anticipation of policy moves as we have seen with bond yields and exchange rates.

Money Supply Trends

We have got used to falling numbers and today was no exception.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, decreased to 6.2% in January from 6.6% in December…….annual growth rate of broad monetary aggregate M3 decreased to 3.8% in January 2019 from 4.1% in December 2018.

If we look at this as a broad sweep then M1 growth has fallen substantially from the 11.7% per annum peak of the summer of 2015 and the bounce to 9.7% in late 2017. Much of this has been a deliberate policy with the monthly QE tap having been reduced and then finally closed at the end of 2018. This has had an impact on the broader measure as well which has also been weakened by this.

The annual growth rate of short-term deposits other than overnight deposits (M2-M1) stood at -0.8% in January, unchanged from the previous month. The annual growth rate of marketable instruments (M3-M2) decreased to 0.4% in January from 0.9% in December.

Putting it another way M3 would be growing at an annual rate of 4% if only M1 was a factor and the wider measures reduced the annual rate of growth by 0.2%.

Comment

The narrow money supply measure proved to be an accurate indicator for the Euro area economy in 2018 as the fall in its growth rate was followed by a fall in economic (GDP) growth. It gives us a guide to the next six months and the 0.4% fall in the annual rate of growth to 6.2% looks ominous. A little relief comes from the fact that inflation has fallen although that may change as we note the recent rises in the oil price. Thus it looks like more of the same weak trend in the early part of 2018.

The broad money measure has declined but in proportionate terms by much less or to put it another way this is mostly the result of the end of QE. This poses a problem as we are reminded of the words of Mario Draghi.

certainly especially in some parts of this period of time, QE has been the only driver of this recovery.

Now we see that as it has ended in terms of monthly flow economic growth in the Euro area has slowed to a crawl. Whether it will slow further I do not know but we seem set for more weak growth in the early part of this year.

Meanwhile some have claimed that bank lending growth is supporting things as opposed to my view that it is a lagging indicator and has been representing the better times seen in 2017. I guess they will be quieter today as even lagging indicators work over time.

Annual growth rate of adjusted loans to non-financial corporations decreased to 3.3% in January from 3.9% in December.

Returning to my opening theme unless there is a change the outlook for house prices in the Euro area looks set for a turn.

 

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