Euro area money supply growth suggests there is inflation ahead

This morning’s Euro area money supply numbers remind me of this from last Friday. The head of the German Bundesbank Jens Weidmann was interviewed by FAZ and dropped something of a bombshell.

Inflation rates will increase strongly, to begin with. For Germany, say, my experts are expecting rates to potentially go in the direction of the 5% mark towards the end of the year.

This brings me back to the point I have consistently made which is that the money supply push we have seen since last March will have inflationary consequences. In a nutshell higher broad money growth or M3 in the Euro area leads to a combination of higher economic growth and inflation. If we go back to the question we see that a message is being sent because it was implying a different view.

Eurozone inflation came to a mere 1.9% in June. For many experts, the latest increase is mainly the result of temporary factors that are expected to have petered out in the coming year. Is that an assessment you would disagree with?

He then switches to what we might call the ECB line.

But that is mainly because temporary effects are at play. These include energy and commodity prices and, in Germany, for example, the reversal of the temporary VAT reduction last year. Inflation rates will therefore undoubtedly decline again significantly after that. The future path is uncertain, however.

The VAT cut was estimated to have affected Euro area inflation by up to 0.6% depending on whether you think it was fully passed through or not.

Next came an area of inflation which the ECB has been desperate to ignore.

What is more, as part of the strategy review we decided, going forward, to incorporate the prices of owner-occupied housing into the consumer price index we use. At present, this raises the inflation rate in the euro area by between 0.2 and 0.3 percentage point.

Even now they are watering it down via the use of rents ( which is clearly being implied above). How much well take a look.

Over the period 2010 until the first quarter of 2021, rents increased by 15.3 % and house prices by 30.9 %.

Or if we look at the latest numbers.

Rents and house prices in the EU have continued their steady increase in the first quarter of 2021, going up by 0.4 % and 2.2 %, respectively, compared to the fourth quarter 2020.

As you can see from the numbers some of the money supply push is finding its way into house prices and the numbers below coincide with the era of negative interest-rates and ever more QE.

 house prices remained more or less stable between 2013 and 2014. Then, there was a rapid rise in early 2015, since when house prices have increased at a much faster pace than rents.

When we are told QE does not create inflation there is the clear issue of them ignoring where it does. Looking ahead adding Imputed Rents may well be better than nothing but misses out so much as well as being a fantasy as owners do not pay rent.

Today’s Data

The situation starts well from the ECB point of view.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, stood at 11.7% in June, compared with 11.6% in May.

This is because it has been trying to increase the amount of QE and hence M1 growth as this from the latest press conference shows.

Therefore, having confirmed our June assessment of financing conditions and the inflation outlook, we continue to expect purchases under the pandemic emergency purchase programme (PEPP) over the current quarter to be conducted at a significantly higher pace than during the first months of the year.

Whilst it is not explicitly stated they have been operating the higher purchases for a while. That will have been much of the 114 billion rise in M1 we saw in June which was nearly as much as the 2 previous months combined.

Going to broad money

Things are not going so well for the ECB here.

The annual growth rate of the broad monetary aggregate M3 decreased to 8.3% in June 2021 from 8.5% in May, averaging 8.7% in the three months up to June.

In plumbing terms the narrow money tap is on but there is a leak somewhere as we move into the banking sector response and by that I mean credit and lending.

credit to general government contributed 5.1 percentage points (down from 5.9 percentage points in May), credit to the private sector contributed 3.6 percentage points (as in the previous month), longer-term financial liabilities contributed 0.3 percentage point (down from 0.5 percentage point), net external assets contributed -0.3 percentage point (down from -0.2 percentage point), and the remaining counterparts of M3 contributed -0.4 percentage point (up from -1.3 percentage points).

So the mover was somewhat ironically the government sector which shows how far they have intervened in economies.

We can also look to see what was happening in the credit arena.

As regards the dynamics of credit, the annual growth rate of total credit to euro area residents decreased to 6.2% in June 2021 from 6.7% in the previous month. The annual growth rate of credit to general government decreased to 13.0% in June from 15.4% in May, while the annual growth rate of credit to the private sector stood at 3.5% in June, unchanged from the previous month.

We get the same message of reducing government involvement.

Another way of breaking down the loans data reinforces my earlier point about housing. Lending growth to households is higher than pre pandemic now but growth in lending to businesses is lower. Is the growth in mortgages?

Among the borrowing sectors, the annual growth rate of adjusted loans to households stood at 4.0% in June, compared with 3.9% in May, while the annual growth rate of adjusted loans to non-financial corporations stood at 1.9% in June, unchanged from the previous month.


We see that the narrow money or M1 push continues in the Euro area which hints at economic growth continuing in the short-term and this does coincide with the Markit PMI.

The eurozone is enjoying a summer growth spurt
as the loosening of virus-fighting restrictions in July
has propelled growth to the fastest for 21 years.

Central bankers avoid explicit mentions of the money supply these days but in this sense they are monetarists. But there is a payback because should the Bundesbank be correct then the broad money push from starting last March will drive inflation higher in the latter months of 2020. This will start to subtract from the growth push so there could be a fade. Maybe markets are staring to allow for that too.


Switching to the value of the Euro then raising the money supply would be predicted by the text books to weaken it, But of course so many are at the same game. But it has drifted a little lower recently.





4 thoughts on “Euro area money supply growth suggests there is inflation ahead

  1. Great blog as usual, Shaun.
    It seems that Herr Weidmann accepts all components of the ECB strategy review. The German economist Peter Bofinger’s assessment of it was “the mountain has given birth to a mouse”:
    which certainly seems fair.
    At the press conference introducing the strategy review, Christine Lagarde said that the strategy review definitely wasn’t introducing an average-inflation targeting regime like the US Fed, and of course the words are never used in the text of the strategy review declaration, but the language in paragraph 6 is vague enough that the euro area might just get some kind of average-inflation targeting light.
    “The European Central Bank (ECB) has from the start of the HICP project [this would mean, for as long as the ECB has existed, and rather late dates the start of the HICP project So] expressed a desire that some measure of the inflation faced by owner occupiers should be included in the HICP, given not only the importance of OOH in the economy as a whole, but also that a housing index may not show the same trend movements as the current all-items HICP.” This is a quote from the 2004 progress report on “Owner-Occupied Housing in the HICP”, relating to pilot indices for five countries, including the UK, that started in 2000.
    But what we get from the 2021 strategy review is this: “the Governing Council recognises that the inclusion of the costs related to owner-occupied housing in the HICP would better represent the inflation rate that is relevant for households. Recognising that the full inclusion of owner-occupied housing in the HICP is a multi-year project, the Governing Council in its monetary policy assessments will, in the meantime, take into account inflation measures that include initial estimates of the cost of owner-occupied housing in its wider set of supplementary inflation indicators.” I’ll say it’s a multi-year project. It’s already a two-decades project. Just how many more decades does the Governing Council mean to string this thing out?
    If you try to make sense, not of the strategy review document itself, but of Lagarde’s vague statement in the press conference that only the consumer part of housing costs and not the investment portion, it constitutes a clear attack on any of the variants of the net acquisitions approach that has been the one and only approach considered by Eurostat from the beginning. If she is really serious about that, she wants to include the depreciation of houses in the inflation measure, not the net acquisitions of new houses or new dwellings. But then she is, for all practical purposes, talking about including dwelling prices, not housing prices, in the inflation measure, i.e. imputed prices, not actual market prices, which is contrary to HICP principles. However, she doesn’t actually go there. Her predecessor, Draghi, indulged in the same kind of vague nonsense.
    If one applies Occam’s razor, one must conclude that the ECB Governing Council does not believe in including housing prices in the HICP. It has never believed in including housing price in the HICP. It just wants to study the issue to death while issuing vague declarations of support that broader inclusion of OOH costs would be a good thing.

    • Hi Andrew and thank you

      We both went through the procedure of following the last effort to introduce a proper effort at measuring housing costs. About two years of swings and roundabouts and then it ended, having added nothing except bureaucracy. I was therefore surprised when it came up again but they must have received complaints and there will be more as they continue to pump up the housing markets.

      But as you say it is being kicked into the long grass by the equivalent of Elliot Daly ( for non rugby fans he is the player who takes the long kicks for the British & Irish Lions).
      “Recognising that the full inclusion of owner-occupied housing in the HICP is a multi-year project,”

      As to Lagarde’s strategy ever more dissent is appearing.

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