Eurozone money update: disappointing response

Eurozone monetary trends suggest that interest rates remain above a “neutral” level.

The ECB’s deposit rate has been stable at 2.0% since June, following a 200 bp reduction over the prior 12 months. Lower rates should be feeding through to money trends by now.

Six-month growth of non-financial M3, however, was 2.4% annualised in October, half its average in the five years before the pandemic and slightly below the level when rate cuts started.

Chart 1

Non-financial M3 comprises broad money holdings of households and non-financial corporations (NFCs). Six-month growth of headline M3, including volatile financial sector money, was even weaker, at 1.8% annualised.

Narrow money growth – as measured by non-financial M1 – is stronger but also below its pre-pandemic average.

There is no sign of acceleration in the latest numbers, with three-month rates of change close to six-month levels.

Broad money probably needs to expand by at least 4% pa to accommodate potential growth of about 1.25% pa and 2% inflation, allowing for a long-run decline in velocity. (The ratio of nominal GDP to non-financial M3 fell by 1.9% pa on average over 2000-19.)

Money growth below this level implies downward pressure on output relative to trend and / or inflation – inconsistent with rates being at “neutral”.

Slow broad money growth is partly attributable to sluggish credit trends: lending to households and NFCs rose by 2.8% annualised in the six months to October, with momentum stable recently.

A drag from ECB QT, meanwhile, has been fully offset by solid buying of government bonds by banks. Purchases have been spread across countries but were largest in France over the past 12 months – chart 2.

Chart 2

Money growth would have been weaker without support from external inflows, reflecting a basic balance of payments surplus and a corresponding rise in banks’ net external assets – chart 3.

Chart 3