This week, the European Central Bank published its ‘Monetary developments in the euro area’ report. And with that, we finally got information on bank deposits in the euro area.
European deposits look a lot better on an aggregate level than in America. Unlike in the United States, where bank deposits are down 3 per cent from a year ago, Eurozone deposits are still growing. That means the risks of traditional bank runs are lower here.
Nevertheless, overall Eurozone bank deposits mask an underlying trend that is precisely one of the catalysts for turmoil in the banking sector in America: the hunt for interest.
The underlying data shows that overnight deposits - which can be withdrawn immediately and usually offer the lowest interest rates - did come down considerably. Compared to a year ago, they are down by one and a half per cent and in the last six months went down by a solid 4.9 per cent. A major reason why those balances are still largely with banks is that alternatives are scarcer than in the US. For instance, money market funds are three times larger, while bank deposits are “only” 30 per cent higher.
But there is another important implication of the hunt for interest. Overnight deposits, together with currency in circulation, make up the M1 Money Supply. This thus immediately explains where M1 Money Supply has fallen by 2.7 per cent over the past 12 months, the sharpest contraction since the ECB’s inception in 1998.
The chart below shows M1 Money Supply growth and Eurozone inflation. Given the extreme movement in M1 Money Supply, it is reasonable to assume that inflation is going to fall. But the relationship should not be overstated. You cannot use this graph to show that inflation is purely a “monetary phenomenom”.
Below is a piece of a comprehensive table showing the relationship between money supply growth and total and core inflation. Since 2010, the correlation between total inflation has slowed 21 months and M1 Money Supply growth is almost 60 per cent. This is significant. Despite this, M1 Money Supply only manages to explain just over a third of the movements in inflation. That 21-month lag is the one that leads to the “best fit”.
Should the ECB be concerned about savers hunting for the highest interest rates, Lagarde & Co. could pre-empt a pause or pivot, for instance by pointing to money growth. But based on core inflation still rising, I would not bet on this right away. It is more likely that the ECB will step up rate hikes further if things remain quiet from now on.
Jeroen Blokland is founder of True Insights, a platform that provides independent research to build diversified multi-asset portfolios. Blokland was most recently head of multi-assets at Robeco. His chart of the week appears every Thursday on Investment Officer.