Eurozone: gloomy monetary developments confirm risk of deflation

Deflationary forces are still at play. A ‘Japanisation’ of the European periphery has not yet been completely averted and further decisive action by the ECB is required.

Monetary developments weakened further in December. The annual growth rate of eurozone M3 monetary aggregate slowed to 1.0% y-o-y in December after posting 1.5% y-o-y growth in November, below consensus expectations (1.7% y-o-y) and posting the lowest annual growth rate since September 2010. Meanwhile, lending to the private sector remained at -2.3% y-o-y in December, an all-time low.

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Slower pace of contraction in non-financial corporation loans
As the counterpart of broad money (M3), the situation remains depressed, although the pace of contraction has softened. Indeed, bank lending to non-financial corporations contracted by €3bn in December, after falling €13bn  in November. Loans to households also showed some weakness as mortgage lending contracted (-€4bn) while credit for consumption picked up only slightly (+€2bn).

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Trend in peripheral SME lending remains negative
In terms of geographical developments, while most countries recorded positive flows in loans to non-financial corporations in December, France, Spain and Greece continued to record negative flows. It is worth noting that Italy posted a healthy monthly gain, although the trend still remains in negative territory. By contrast, Spain (-€13bn) recorded the sharpest monthly drop in 2013.

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M1 suggests weak growth in quarter ahead
The evolution in narrow money M1, traditionally a good leading indicator of economic activity, added some gloom to the poor monetary picture published today. M1 growth slowed from 6.5% y-o-y in November to 5.8% y-o-y in December. As a result, real M1 tends to suggest that the recent GDP rebound could prove to be only temporary and may soften in the quarters ahead. These conclusions have to be taken with a pinch of salt as M1 dynamics are, in large part, determined by exceptional factors as banks are currently making massive LTROs repayments. Nevertheless, monetary developments suggest that the current economic recovery is still fragile and not yet underpinned by all the necessary factors to make it sustainable.

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Deflationary context put pressure on the ECB to act
All in all, today’s data confirm that deflationary forces are still at play. A ‘Japanisation’ of the periphery has not yet been completely averted. Further decisive action by the ECB is required to inflate its balance sheets and decouple from the Fed’s tapering. Decisions to revive the ABS market, notably bank loan securitisation, as suggested by Mario Draghi’s recent comments, would be most welcome in order to stimulate bank lending to SMEs and therefore reduce fragmentation and maintain a safety margin against deflation.

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