Author: Edward Hugh
According to Ralph Atkins, writing in the Financial Times:
“Eurozone mortgage borrowing grew last month at the fastest pace in almost two years in a sign that bank lending across the 16-country region may be flickering back to life. Lending for house purchases rose at an annual rate of 3.4 per cent in June – the fastest since September 2008, according to European Central Bank data published on Tuesday. The acceleration pointed to a revival in consumer confidence and an increased willingness by banks to fuel the economic recovery with loans to the private sector.”
The problem is that behind the positive aggregate data lie the individual national details (you know, the place where the devil is usually to be found), and when we dig down to this level, then we find the position is much more complicated than it seems. Nor should this surprise us, since if a one-size-fits-all interest rate policy didn’t work in the pre-2008 world (just look what happened to Spain and Ireland for heavens sake), is there any good reason to assume that it will in a post-2010 one?
To take the two extreme cases, France and Spain, in France mortgage lending was up by an annual 5.3% in June (considerably above the aggregate average of 3.4%), and not only this, lending has in fact been accelerating since it hit a trough in October last year (see chart below).
In Spain, on the other hand, mortgage lending continued to languish, rising by only an annual 0.9%.
Indeed, lending to households generally was up in France, by an interannual 4.4%
while in Spain total lending to households was only up by 0.5% over June 2009.
This is not simply a question of there being a vicious credit crunch operative in Spain (which there most certainly is), but one of different relative levels of indebtedness, since total household debt in Spain is 902 billion euros (or around 90% of GDP), while in France it is just a fraction under 1,000 billion euros (or just a tad over 50% of GDP). So French households have the capacity to leverage themselves more, while Spanish households are dangerously overleveraged, and herein lies the danger for the ECB, with its single interest rate policy limitation. Not raising rates risks fuelling a sizeable consumer credit and construction boom in France, while in Spain raising them (given that in Spain around 90% of mortgages are with variable rates) it means flooding the Spanish banking system with non-performing loans.
In fact the situation in the construction industry is quite different between the two countries, In Spain construction seems (for the time being) to be in near terminal decline.
while in France construction activity may not have revived, but then it never fell as dramatically as it did in Spain.
Nor did industrial output fall as far or as fast, as it did in Spain.
Retail sales reveal a rather similar picture
As do the respective services PMIs.
Jack Kennedy, economist at Markit and author of the France Services PMI, said:
“Growth momentum in France remained marked during June, rounding off a strong Q2. A solid gain in service sector employment – the sharpest since April 2008 – is encouraging for the labour market and, by extension, consumer spending. Overall, the upturn appears to still have considerable traction despite signs of a recent cooling of growth in the manufacturing sector.”
Commenting on the Spanish Services PMI survey data, Andrew Harker, economist at Markit and author of the report said:
“Latest Spanish service sector PMI data provide some worrying signs regarding the path of the sector. Foremost among these is the first drop in new business since February. Also of note is the marked weakening of sentiment seen in the previous two months amid worries surrounding austerity measures in Spain and the effects these will have on the fragile economy.”
So the divergence between these two economies couldn’t be clearer at this point. While house prices continue to fall in Spain.
In France there is already evidence of an uptick.
Of course, this is still early days yet. But lets just remember how Spain got into the mess it is currently in.
During the key years of the construction bubble negative interest rates were applied to a booming Spanish economy (the yellow parts of the chart above, looks like a dental X-ray showing where you need the filling, doesn’t it?). So what is happening now in France?
As can be seen (blue patch at the end), since December last year the French inflation rate has been above the Eurozone 16 one, something that has almost never been the case since the Euro came into existence. And since almost the same date French interannual inflation has been above the ECB policy rate of 1%. That is to say, negative interest rates are being applied to the French economy. Possibly there was no harm in that while that economy was in the midst of the deepest recession in a decade, but now the French economy is showing clear signs of recovery and the remedy (along with the massive “emergency” liquidity provision from the ECB) simply isn’t called for.
But if we come to look at the French goods trade balance (a sure early warning indicator of problems to come) we can see that the trade deficit is widening again, which basically means that French industry is once more losing competitiveness, and the economy becoming structurally distorted (note the point in the French PMI quote about the weakening manufacturing performance just as the services sector is accelerating). This is just what happened to the Spanish industrial sector in its day.
So as Ralph Atkins says, “The pick-up in mortgage lending could offer some cheer after months of gloomy eurozone bank lending data and fears about the stability of the region’s banking system” – but it could also add to the worries too. As far as I can see there are only two ways around this problem, either start increasing rates at the ECB, or press for a substantial internal devaluation to restore economic growth in Spain, but both of these routes pose serious issues for the stability of the Spanish banking system, since in the former case the burden of mortgage interest payments becomes excessive (and quickly – simply raising the refi rate from 1% to 2.5% would represent an almost 100% increase in mortgage service costs given the close attachment between Spanish mortgages and 1 year Euribor), while in the latter the reduced nominal incomes make the burden of the mortgage repayments even more weighty, with almost inevitably the same result – more mortgages going “bad”. One thing is for sure though, some sort of solution or other needs to be found, and soon, if not the one Eurozone economy where domestic consumption isn’t a dead man walking at this point may be sent on a roller coaster ride which is in no-one’s interest.