Euro Area Credit Contraction Continues‏

Euro area M3 growth stood at 2.3% y/y in August, up from 2.3% in July, in line with market expectations. At the same time, M1 growth declined to 6.8% y/y, from 7.1%. The high M1 is driven primarily by increasing overnight deposits. Deposits are increasing for both households and non-financial corporations.

Loans to the private sector are down 2.0% y/y, from 1.9% y/y in July. However, it is more interesting to look at the monthly loan flows in order to detect a turning point as early as possible. Unfortunately, the monthly loan flows give the same message - there is no turning point yet.

Loans to non-financial corporations continued to decline albeit at a slightly slowing pace. Thus, it seems that the credit contraction has continued despite the improvement in other data. The decline in loans to non-financial corporations is driven not only by Spain but is also visible in, for example, German data. The continued decline in lending is one of the key risks to our euro area recovery story. It might be explained partly by a structural shift towards more large enterprises tapping the market directly but it is also likely to be driven by banks attempting to deleverage and take into account new regulation.

Monthly loan flows to households were slightly positive but only just reversed a small decline in the previous month. On a positive note, household lending is expanding decently in both Germany and France.

The ECB's monetary analysis should give plenty of room for the ECB to ease monetary policy further. The economic analysis should reach the same conclusion. We expect that the ECB will hold its fire with regard to lowering official interest rates. Instead, we expect the ECB to provide a new three-year long-term refinancing operation (LTRO) when excess liquidity has declined so much that it pushes the short market rates towards the refi rate. In our view, this is likely to happen late this year or early next year.

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