E Economics

Latest Monetary Developments in the Eurozone Point To A Gloomy Outlook

28 June, 2023
Eurozone Monetary Developments

Latest monetary developments in the Eurozone showed that lending to businesses and households deteriorated again in May. In a context where the ECB looks on track to tighten further its monetary policy, the economy is likely to face a longer recession than expected.

According to the ECB, the annual growth rate of the broad monetary aggregate M3 decreased to 1.4% in May 2023 from 1.9% in April, averaging 1.9% in the three months up to May. In the meantime, the annual growth rate of the narrower aggregate M1, which comprises currency in circulation and overnight deposits, was down 6.4% in May, compared with -5.2% in April. Taking into consideration inflation, real M1 — usually a leading indicator of GDP — declined by 12.5% YoY, pointing to a gloomy outlook for the coming months.

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In the meantime, data also revealed the annual growth rate of adjusted loans to the private sector (i.e. adjusted for loan sales, securitisation and notional cash pooling) decreased to 2.8% in May from 3.3% in April. Among the borrowing sectors, the annual growth rate of adjusted loans to households decreased to 2.1% in May from 2.5% in April, while the annual growth rate of adjusted loans to non-financial corporations decreased to 4.0% in May from 4.6% in April.

Looking at most recent figures (6-month variation annualized), the trend is worrying with credit to the private sector on the verge of contraction. Without surprise, lending for house purchase (households) is already falling, partly explaining home prices’ decline in several countries including Germany.

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Meanwhile, there is a risk that several banks reduced lending further in the coming months as deposits’ outflows persisted in May.

The key problem is that monetary developments in the Eurozone are unlikely to improve in the short term with ECB on track to raise rates and tighten further its balance sheet. At this stage, traders expect ECB to raise rates in July and September (probability of 65%). Separately, banks repaid a significant amount of TLTRO on Wednesday while, according to Bloomberg, “Some hawkish European Central Bank officials are pondering options to speed up the reduction of the institution’s €5 trillion ($5.5 trillion) stash of bonds“.

*Bottom line: Latest monetary developments in the Eurozone already point to a gloomy outlook for the coming months, particularly for the housing sector. Conditions are unlikely to improve soon in a context where ECB is likely to tighten further its monetary policy. As a result, Eurozone economy is likely to face a longer recession than expected. It also means that consensus of economists looks optimistic concerning Eurozone GDP forecasts for both 2023 (+0.6%e) and 2024 (+1.0%).