The Eurozone has witnessed a significant contraction in its money supply, marking the first occurrence of such an event since 2010. This financial development has been catalyzed by a slowdown in private-sector lending coupled with a decline in deposits, casting a shadow of concern among economists who predict a potential downturn in the near future.
The money supply, a pivotal metric monitored with keen attention by the European Central Bank (ECB), serves as a barometer to gauge the ramifications of recent monetary policy tightening. The deceleration in lending activity alongside the reduction in short-term deposits is anticipated to lead to a deceleration in economic activity, subsequently dampening inflationary pressures.
The most recent data is poised to contribute to the ongoing discourse within the ECB’s governing council. The question of whether to halt interest rate hikes, an unprecedented consideration since July 2022, will take center stage during the council’s imminent meeting scheduled for September 14.
Divergent viewpoints are emerging within the council. Advocates of a more dovish approach contend that inflation is already in retreat, warning against further rate hikes that could potentially trigger an unnecessarily severe recession. In contrast, the proponents of a more aggressive stance argue that the inflation rate of 5.3 percent in July significantly overshoots the ECB’s 2 percent target. This dichotomy has prompted economists to label the impending decision as a “coin toss,” with the outcome potentially hinging on the magnitude of inflation’s retreat once the August data is unveiled on Thursday.
The ECB’s comprehensive measure of money circulating within the Eurozone, encapsulated in the M3 figure comprising deposits, loans, cash in circulation, and various financial instruments, experienced a contraction of 0.4 percent in the year leading up to July. This stands in stark contrast to the growth of 0.6 percent recorded in June, as stated by the ECB on Monday.
Economists assert that these statistics underscore the efficacy of the ECB’s strategic decisions over the past year. The substantial elevation of the benchmark deposit rate from a negative 0.5 percent to an impressive 3.75 percent, along with the deliberate reduction of the central bank’s balance sheet, appears to be yielding the intended results, thereby strengthening the argument in favor of a pause in rate hikes.
Frederik Ducrozet, Head of Macroeconomic Research at Pictet Wealth Management, elucidated on the situation through his social media platform, stating that the credit growth contraction for both corporate and household sectors is a deliberate facet of monetary policy rather than an unintended consequence. This, he contends, provides the ECB with the latitude to consider an imminent cessation of rate hikes.
At the crux of the Eurozone’s first money supply contraction in 13 years lies the decline in annual growth of lending to the private sector, stagnating at a mere 1.6 percent in July. This represents the slowest pace since 2016. Concurrently, lending to governments also experienced a notable decrease of 2.7 percent—its most substantial drop since 2007.
Bert Colijn, an economist at Dutch bank ING, highlighted the rapid downtrend in annual growth for bank lending, attributing this phenomenon to a sharp decline in borrowing within the business sector, as well as a consistent downward trajectory in household borrowing, predominantly associated with mortgages.
Intriguingly, both businesses and households have been reallocating funds away from overnight deposits at an unprecedented rate, resulting in a 10.5 percent plunge in the year leading up to July. This shift primarily corresponds to an upsurge in higher-yielding fixed-term deposit accounts, which surged by a remarkable 85 percent within the same period.
Consequently, total deposits, encompassing not only households and corporations but also government entities and financial institutions, encountered a record decline of 1.6 percent in the year preceding July.
As Colijn articulates, “With economic activity currently languishing in a state of stagnation, monetary policy is poised to contribute to a fragile economic landscape in the coming quarters.” While the Eurozone economy exhibited a modest growth of 0.3 percent during the second quarter of the year, the preceding two quarters had experienced contraction or stagnation. Disheartening business surveys further substantiate predictions of an impending downturn in the three-month period up to September.
