Euro area: on track to normalisation

M1 growth accelerated, suggesting that euro area economic activity is likely to gain momentum in the quarters ahead.

Four drivers are currently supporting the euro area recovery: the crude oil price drop, euro depreciation, the end of austerity and, finally, expansionary monetary policy. Monetary aggregates have already started the normalisation process ahead of the launch of the ECB’s QE. It is essential that these forces last for a while to give the still fragile recovery process a chance.

M3 growth: close to its long-term reference value
The annual growth rate of euro area money supply (M3) accelerated further from an upwardly revised 3.8% y-o-y in December to 4.1% y-o-y in January, above consensus expectations (3.7%). January’s reading was the highest since April 2009. It is now close to its long-term reference value (4.5%).

As the counterpart of broad money supply (M3), lending to the private sector continued to contract for the 33rd consecutive month, albeit at a much slower pace (-0.1% y-o-y in January from -0.5% y-o-y in December).

Euro_Agg_02.03.2015-1

Loans to companies: back in negative territory
In terms of flows, bank lending to non-financial corporations contracted by €4bn in January, after expanding by €10bn in December. Meanwhile, loans to households increased again owing to a rise in mortgage lending (+€4bn), whereas credit for consumption was flat.

Euro_Agg_02.03.2015-2

Sharp increase in M1 growth
The increase in M3 aggregate was driven by a pick-up in narrow monetary aggregate. Indeed, M1 surged to 9.0% y-o-y in January, from 7.9% y-o-y in December, the highest acceleration since June 2010. This jump was essentially due to a marked rise in overnight deposits. Recent ECB purchases of covered bonds and ABS as well as the end of the LTRO repayment may explain this strong increase. Real M1 growth – traditionally a good leading indicator of economic activity – suggests that euro area economic recovery is likely to accelerate in the quarters ahead, in line with recent surveys, i.e. PMI and EC survey.

Euro_Agg_02.03.2015-3

An important support to the recovery
Overall, data confirm that monetary aggregates are on their way to recovering further, although credit dynamic remains weak compared with historical levels. In the coming months, narrow monetary aggregates are likely to accelerate, on the back of the ECB’s QE starting in March, TLTRO operations (next scheduled for March) and the end of LTRO repayments. These developments could thus mark the beginning of the process of monetary normalisation in the euro area – an important prerequisite for creating money, anchoring inflation expectations, relaxing monetary conditions for the economy and depreciating the euro. These developments therefore tend to confirm that money creation will finally be an important support for euro area recovery in 2015.

That said, this is a long process that is unlikely to reverse the situation rapidly on the inflation front. In the meantime then, assuming crude oil prices remain unchanged, inflation is unlikely to return to positive territory in the short term.

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