Surprise fall in money supply gives warning to ECB on rates

BROAD EURO-zone money supply posted a surprise drop in November while loans to households and firms fell for the third month running, serving a warning to the European Central Bank that it must tread carefully with its exit strategy.

M3 broad money supply, a measure of cash available to spend in the economy, fell 0.2 per cent year-on-year in November, far weaker than analysts’ expectations of growth of 0.3 per cent and the first fall since records began in 1991.

It comes despite the ECB lending banks billions of euro of extra funds since the start of the financial crisis in the hope of propping up bank lending to firms and households.

Economists said it was a fresh warning to the ECB to go slow with its recently sketched-out plans to remove the emergency support.

“Overall, the euro-zone money supply and credit data for November support the case for the ECB to only very gradually withdraw its emergency liquidity measures, and to keep interest rates down at 1.0 per cent until deep into 2010,” said IHS Global Insight analyst Howard Archer.

The data was not all downbeat, however. Loans to the private sector also fell, but the 0.7 per cent annual drop was less pronounced than analysts had forecast, bolstered by stronger demand for mortgages and consumer credit.

The two elements are often seen as leading indicators of credit trends.

“This is a very mixed signal,” said Nomura economist Laurent Bilke. “On the one hand we had M3 year-on-year growth come in weaker . . . On the other hand we have the continuation of what we have observed recently for loans to households – in particular for housing purchases – to improve.”

ECB policymakers and economists say that the current drop in credit is more to do with a fall in demand rather than banks choking supply, although some business leaders have suggested otherwise.

The surprise drop in money supply will not go unnoticed at the Frankfurt-based ECB, which sets interest rates for the 16 countries that use the euro.

A Reuters poll showed 26 economists on average expected 12-month M3 growth of 0.3 per cent, with forecasts ranging from zero to 0.5 percent. For private loans, economists on average expected a 1.0 per cent drop, with a forecast range of -1.1 per cent to -0.6 per cent.

“While we were forecasting a further slowdown and a third consecutive negative monthly flow (M3), we did not expect such a large slowdown,” said economists at UniCredit.

They added that they expected the ECB to keep euro zone interest rates at their current record low of 1 per cent throughout the whole of 2010.

Figures released by the Irish Central Bank as part of the ECB’s survey showed the annual rate of change in headline private sector credit fell further in November, to minus 5.2 per cent.

When valuation effects are taken into account, the underlying stock of private sector credit was approximately 1.7 per cent lower in November 2009 when compared with a year earlier. – (Reuters)