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The euro zone’s money supply has shrunk for the first time since 2010 as private sector lending stagnated and deposits fell, and economists have warned that financial tightening portends further economic downturns ahead.

The money supply is one of the ECB’s main indicators for monitoring the impact of recent monetary policy tightening. Economic activity is expected to slow and inflationary pressures to cool as lending dries up and short-term deposits shrink.

The latest data will set the stage for debate at the ECB’s next meeting on Sept. 14 over whether to pause rate hikes for the first time since July 2022.

The more dovish members of the committee said inflation was already falling and further rate hikes could lead to an unnecessarily painful recession. But hawks believe July’s inflation rate of 5.3% is still well above the ECB’s 2% target. Economists said the decision was a “coin toss” that may depend on how much inflation fell in August when the data is released on Thursday.

The ECB’s measure of money in the euro zone system as a whole — M3 data that includes deposits, loans, cash in circulation and various financial instruments — fell 0.4% in the year to July, down from a 0.6% gain in June . Said Monday.

Economists said data showing an unprecedented rise in the ECB’s benchmark deposit rate from -0.5% to 3.75% over the past year and the shrinking of its balance sheet was working as expected, supporting the case for a pause.

Line chart showing funds moving out of overnight deposits at a record pace

“On the asset side of bank balance sheets . . . things look tough as corporate credit growth collapses, especially household credit growth,” Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management, wrote on social media platform X. Oops. He said this was “a feature of monetary policy, not a bug” and meant that “the ECB could (should) stop raising rates sooner”.

The first drop in the euro zone’s money supply in 13 years was largely driven by a drop in annual growth in lending to the private sector to an annualized 1.6% in July, the slowest since 2016. Lending to the government also fell 2.7% – the biggest drop since 2007.

“Annual growth in bank lending continues its rapid downward trend,” said Bert Colijn, economist at ING. driven by a downward trend.”

Businesses and households moved money out of overnight deposits at a record pace, down 10.5% in the year to July. That largely reflects a switch to higher-yielding term deposit accounts, which have grown 85 per cent over the same period.

Overall deposits, which include deposits held by government agencies and financial institutions as well as households and companies, fell 1.6% to a record high in the year to July.

“With economic activity already at a standstill, monetary policy will lead to a weaker economic environment in the coming quarters,” Colin said.

The euro zone economy grew 0.3 percent in the three months to June from the previous two quarters, when it contracted or stagnated. But downbeat business surveys pointed to a possible downturn in the three months to September.

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