Euro Area Credit Contraction Rings Alarm At ECB‏

Euro area M3 growth declined from 2.1% in September to just 1.4% in October - well below consensus expectations of 1.7%. The continued decline in M3 growth should ring an alarm bell at the ECB.

M1 growth has declined for five consecutive months now but showed some signs of stabilisation as it only posted a modest decline from 6.7% to 6.6%. M1 growth at this level suggests that GDP growth in the euro area should be around 0.3% q/q on a six-month horizon, which is broadly in line with our expectations (although a bit on the low side). Five months ago M1 growth signalled that growth could reach almost twice that. If we look at real M1 growth instead, the weakening of this growth signal appears less alarming.

Loans to the private sector continue to decline and adjusted for sales and securitisations the pace of decline increased slightly again (from -1.6% in September to -1.7% in October). We prefer to look at the monthly loan flows to better detect turning points. The monthly loan flows showed signs of improvement for a couple of months, but today's data unfortunately suggests a renewed small deterioration in both loans to households and loans to enterprises. In particular, credit for consumption declined while loans for house purchase improved further. Loans to enterprises continue to decline - at a slightly increased pace.

The continued decline in lending is one of the key risks to our euro area recovery story. The decline in loans to non-financial corporations is driven not only by Spain and Italy, but is also visible in, for example, German data. It might be partly explained by a structural shift towards larger enterprisers tapping the market directly, but is also driven by banks attempting to de-leverage ahead of the ECB taking its snapshot of their balances on 31 December 2013 for the Asset Quality Review. Loan demand from both enterprises and households has shown signs of improvement recently, which gives some reason to believe that bank lending data will begin to improve early next year.

All in all, the ECB's monetary analysis should give it good reason to consider whether it is doing enough. We expect the ECB to be on hold in December, but today's data should certainly help to keep it on an easing bias and we will probably see more action in 2014.

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