Monetary Contraction Continues in Europe

Simon Ward at Money Moves Markets updates us on the latest monetary aggregates from the eurozone and despite strong global growth in excess liquidity and central bank expansion, money growth remains weak in Europe. Going out of 2011, 6 month nominal M1 growth in the eurozone was at a level similar to October 2008 and May 2010.

Money growth in the US has so far stayed strong which has supported money growth in the developed world. In the emerging world, most central banks are moving towards a focus on growth over inflation. This is bullish for money growth but the easing cycle will be gradual as EM central banks will continue to watch inflation developments closely.

The most important story in the eurozone is the strong outflow of deposits from the periphery.

Greece and Ireland in particular have seen an unprecedented surge in outflows, but as Simon Ward points out there is divergence across the entire periphery versus the core.

 A 1.0% (not annualised) fall in Eurozone real M1 deposits in the six months to January conceals a solid 2.2% rise in “core” economies (defined here as Austria, Belgium, France, Germany, Luxembourg and the Netherlands) offset by a 6.1% plunge in the “periphery” (i.e. Greece, Ireland, Italy, Portugal and Spain). The latter represents a new low, suggesting that the rate of peripheral GDP contraction will accelerate in mid 2012.

We agree. There are no immediate bright spots on the horizon for the periphery except perhaps the fact that Spanish and Italian yield curves have steepened on the back of the ECB’s LTRO operations. In addition, and while the relative change in money supply growth between the periphery and the core is important, it is also telling to observe that the nominal value of deposits in the eurozone (re-based in 2009) is still flat to down. This shows the extent to which Europe, as a whole, is stuck in a very vicious deleveraging cycle.

The outlook for money growth in the periphery is tied to confidence and, to some extent, ECB policy. Given the degree of planned fiscal retrenchment and the fact that banks, at best, use LTRO liquidity to play the carry trade on the short end of the government bond curves there is little hope for an immediate pick-up in the money supply in the periphery. In this sense, the monetary transmission mechanism to the real economy has been thoroughly broken in the eurozone.

However, the ECB’s response has still been powerful in terms of quantitative expansion of the potential money supply and in this way excess liquidity. This has been done through an unprecendented expansion of the ECB’s balance sheet through extensive open market operations to the European banking sector (and to a lesser extent through direct purchases of government bonds).

In the second half of 2011, the ECB’s balance sheet as a share of eurozone GDP rose from about 20% to 30%. While this may not revive lending to the real economy it has helped stabilize global risk asset prices as well as to avoid a collapse of the European banking system.

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