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Credit Impulse Update: The great Eurozone divide
Summary: The widening economic performance chasm between the core and periphery of the Eurozone makes policy intervention inevitable. Expect the reappearance of our 'old friend' TLTRO and maybe a few innovative measures too.
Low euro area credit impulse and monetary policy options
Our favourite leading indicator, the euro area credit impulse – a major driver of economic activity – is back in positive territory, running at 0.4% of GDP, after a negative print at the beginning of 2018. However, the positive pulse remains very limited compared with its 4-year average of 0.8%. A country by country analysis shows that core countries and the periphery of the euro area are decoupled. In France and in Germany, credit impulse is broadly well-oriented. It is slightly above 0.6% of GDP in Germany and it is rising again in France to nearly 1.7% of GDP, which has certainly helped to mitigate the negative macroeconomic impact of the Yellow Vest crisis in Q4 2018.
By contrast, credit impulse is sharply decelerating in the periphery of the euro area. It is close to zero in Q4 2018 in Italy and it is sinking more and more into negative territory in Spain, at minus 2.1% of GDP, a level that had not been reached since the end of 2013. It clearly confirms what we have said since early 2018: the euro area has entered into a more restrictive credit cycle, especially in the periphery, that will have negative impact on domestic demand – as it is highly correlated to the flow of new credit in the economy – and, ultimately, will lead to lower growth than consensus opinion and the European Central Bank expect in 2019.
This is more or less the same message sent by the last ECB’s bank lending survey: as of today, monetary transmission looks fine but we notice some deterioration in credit access that is expected to continue in coming months (notably moderated loan demand, due to higher risks to growth and consumption, and tightened credit standards in the periphery that will cause lower flow of new credit).
New TLTROs are a done deal
In 2019, low growth is the euro area's top problem. As we all know, growth is all about credit, especially in a period of history where central banks have opened widely the door to low interest rate debt. Since the beginning of the year, we have noticed that policymakers are getting more and more pessimistic about growth expectations, which led them to think again about the need for further stimulus. As fiscal stimulus is off the table for the moment – but not for long: “Fiscal policy reaction is needed in case of big shock” (Jens Weidmann, February 27) – the focus is mostly on monetary policy.
It is striking to realise how fast the change of heart has occurred. In past October, Mario Draghi said that only “a couple” of members of the ECB governing council mentioned the issue of targeted longer-term refinancing operations – in other words, “move along, there’s nothing to see here”! Three months later, he reported that “several” members talked about it – growing concern – and, now, even the more sceptical ECB members, such as Benoit Coeuré, confirm that the topic is back on the agenda.
To understand why financial markets will buzz about TLTROs in the coming weeks, we first need to assess the current situation of the European banking sector. If we look at stock price as a proxy of investors’ confidence, we can safely say that European-listed banks have not regained investors' trust yet. This has not been a real issue until now since, over the past years, through the TLTROs operation, banks have had access to ultra-low-cost ECB money, avoiding paying the high-risk premium related to market borrowing. Through the ECB channel, banks were able to provide cheap credit to euro area households and firms, ultimately strengthening investment and consumption.
The problem is that banks are facing the “TLTROs cliff” in June – this is at that time that the first TLTRO operation runs into its last year and, as of next June, it will already have a strong impact on regulatory liquidity (notably the Net Stable Funding Ratio). As bank won’t be able to have access to new ECB funding, they will have no other choice than to resort to market borrowing at a higher cost than they used to have. For the weakest banks, such as small and medium Italian banks, they may even face quite a challenge to raise money. As funding cost will move upward, weak and strong banks will certainly pass it on to their clients, leading to tighter monetary conditions, lower credit impulse, and stricter access to credit.
To avoid this scenario that would speed up economic slowdown in the euro area, the ECB is expected to launch a new round of TLTROs. It is almost a done deal. At this stage, the main uncertainty is to know when the operation will start and whether it will be part of a larger stimulus package.
Monetary policy innovation on the way
Raising the issue of TLTROs but also other additional measures that could be taken to support the economy underscores the prevailing
scepticism about the ability of TLTROs – implemented alone – to stimulate enough growth and the flow of credit. Contrary to what is too often said, the ECB is not running out of ammunition yet. We strongly believe that monetary policy is all about experimentation and there are still many instruments available in the toolbox. As of today, discussions are evolving around two mains topics that could be part of a stimulus package along with TLTROs:
- A change in forward guidance that could happen as soon as next week, as hinted by the soon-to-be ECB chief economist Philip Lane – in other words, “lower for longer” to strengthen the accommodative stance and insights about reinvestment policy;
- Pushing the depo rate back to zero. Among ECB watchers, this is the most commented measure, after the TLTROs. The rationale behind this idea is that the benefit of negative rates is rather low. Basically, they are a tax on banks, which tends to further enfeeble the weakest banks. So far, the positive impact has been limited and has strongly depended on the structure of banks. The normalisation of the depo rate would be an easy step in order to reduce pressure on the banking sector in a context of less accommodative financial conditions and tougher regulation.
We are aware that these measures are insufficient to cope with a sharp economic downturn, but they could be well-adapted to cope with the current situation, which essentially consists of slower growth and raising concerns on German economy, and to face the TLTROs cliff in June. It is probably one step too far to already discuss other instruments that, in our view, will inevitably need to be coupled with fiscal stimulus.
Our favourite leading indicator, the euro area credit impulse – a major driver of economic activity – is back in positive territory, running at 0.4% of GDP, after a negative print at the beginning of 2018. However, the positive pulse remains very limited compared with its 4-year average of 0.8%. A country by country analysis shows that core countries and the periphery of the euro area are decoupled. In France and in Germany, credit impulse is broadly well-oriented. It is slightly above 0.6% of GDP in Germany and it is rising again in France to nearly 1.7% of GDP, which has certainly helped to mitigate the negative macroeconomic impact of the Yellow Vest crisis in Q4 2018.
By contrast, credit impulse is sharply decelerating in the periphery of the euro area. It is close to zero in Q4 2018 in Italy and it is sinking more and more into negative territory in Spain, at minus 2.1% of GDP, a level that had not been reached since the end of 2013. It clearly confirms what we have said since early 2018: the euro area has entered into a more restrictive credit cycle, especially in the periphery, that will have negative impact on domestic demand – as it is highly correlated to the flow of new credit in the economy – and, ultimately, will lead to lower growth than consensus opinion and the European Central Bank expect in 2019.
This is more or less the same message sent by the last ECB’s bank lending survey: as of today, monetary transmission looks fine but we notice some deterioration in credit access that is expected to continue in coming months (notably moderated loan demand, due to higher risks to growth and consumption, and tightened credit standards in the periphery that will cause lower flow of new credit).
New TLTROs are a done deal
In 2019, low growth is the euro area's top problem. As we all know, growth is all about credit, especially in a period of history where central banks have opened widely the door to low interest rate debt. Since the beginning of the year, we have noticed that policymakers are getting more and more pessimistic about growth expectations, which led them to think again about the need for further stimulus. As fiscal stimulus is off the table for the moment – but not for long: “Fiscal policy reaction is needed in case of big shock” (Jens Weidmann, February 27) – the focus is mostly on monetary policy.
It is striking to realise how fast the change of heart has occurred. In past October, Mario Draghi said that only “a couple” of members of the ECB governing council mentioned the issue of targeted longer-term refinancing operations – in other words, “move along, there’s nothing to see here”! Three months later, he reported that “several” members talked about it – growing concern – and, now, even the more sceptical ECB members, such as Benoit Coeuré, confirm that the topic is back on the agenda.
To understand why financial markets will buzz about TLTROs in the coming weeks, we first need to assess the current situation of the European banking sector. If we look at stock price as a proxy of investors’ confidence, we can safely say that European-listed banks have not regained investors' trust yet. This has not been a real issue until now since, over the past years, through the TLTROs operation, banks have had access to ultra-low-cost ECB money, avoiding paying the high-risk premium related to market borrowing. Through the ECB channel, banks were able to provide cheap credit to euro area households and firms, ultimately strengthening investment and consumption.
The problem is that banks are facing the “TLTROs cliff” in June – this is at that time that the first TLTRO operation runs into its last year and, as of next June, it will already have a strong impact on regulatory liquidity (notably the Net Stable Funding Ratio). As bank won’t be able to have access to new ECB funding, they will have no other choice than to resort to market borrowing at a higher cost than they used to have. For the weakest banks, such as small and medium Italian banks, they may even face quite a challenge to raise money. As funding cost will move upward, weak and strong banks will certainly pass it on to their clients, leading to tighter monetary conditions, lower credit impulse, and stricter access to credit.
To avoid this scenario that would speed up economic slowdown in the euro area, the ECB is expected to launch a new round of TLTROs. It is almost a done deal. At this stage, the main uncertainty is to know when the operation will start and whether it will be part of a larger stimulus package.
Monetary policy innovation on the way
Raising the issue of TLTROs but also other additional measures that could be taken to support the economy underscores the prevailing
scepticism about the ability of TLTROs – implemented alone – to stimulate enough growth and the flow of credit. Contrary to what is too often said, the ECB is not running out of ammunition yet. We strongly believe that monetary policy is all about experimentation and there are still many instruments available in the toolbox. As of today, discussions are evolving around two mains topics that could be part of a stimulus package along with TLTROs:
- A change in forward guidance that could happen as soon as next week, as hinted by the soon-to-be ECB chief economist Philip Lane – in other words, “lower for longer” to strengthen the accommodative stance and insights about reinvestment policy;
- Pushing the depo rate back to zero. Among ECB watchers, this is the most commented measure, after the TLTROs. The rationale behind this idea is that the benefit of negative rates is rather low. Basically, they are a tax on banks, which tends to further enfeeble the weakest banks. So far, the positive impact has been limited and has strongly depended on the structure of banks. The normalisation of the depo rate would be an easy step in order to reduce pressure on the banking sector in a context of less accommodative financial conditions and tougher regulation.
We are aware that these measures are insufficient to cope with a sharp economic downturn, but they could be well-adapted to cope with the current situation, which essentially consists of slower growth and raising concerns on German economy, and to face the TLTROs cliff in June. It is probably one step too far to already discuss other instruments that, in our view, will inevitably need to be coupled with fiscal stimulus.