Eurozone banks stopped selling sovereign bonds in November, possibly in response to the ECB's one-year lending operation conducted in late October and quarter-point rate cut in early November.

Banks bought €1.4 billion of euro-denominated general government bonds in November following sales in each of the prior four months, totalling €59.1 billion. (The figures are from table 2.6 from the ECB's Monthly Bulletin.)

The news is marginally encouraging for ECB officials hoping that the much larger three-year lending operation conducted last week, and follow-up rate cut in early December, will cause banks to rebuild their bond portfolios, thereby achieving “backdoor QE”.

The ECB is aiming for a repeat of 2008-09, when an increase in lending via refinancing operations of €361 billion during the fourth quarter of 2008 contributed to banks purchasing a record €231 billion of government bonds in 2009. ECB lending has increased by €286 billion so far this quarter (i.e. as of 23 December).

Elsewhere in today’s monetary statistics, broad money M3 fell by 0.1% in November following a 0.5% October decline but narrow money M1 edged up by 0.3%, reversing a September / October drop. Six-month growth in real M1 remains just in positive territory, suggesting a mild region-wide recession. (Real M1 outperforms M3 as a leading indicator of the economy.)

Aggregate real M1 stability, however, conceals respectable expansion in the core offset by continued rapid contraction in peripheral economies, suggesting severe recessions in the latter that will undermine fiscal consolidation plans. Trends remain extreme in Greece and Portugal, with real M1 deposits falling at annualised rates of 22% and 18% respectively in the six months to November.

The ECB’s weekly balance sheet statement shows that its conventional lending to the banking system (i.e. in refinancing operations, excluding “emergency liquidity assistance”) expanded by €214 billion or 32% between Friday 17 December and Friday 23 December. The €489 billion taken up in last week’s three-year LTRO, in other words, was offset by a repayment of €275 billion of shorter-term borrowing.

The main counterpart to the lending expansion on the liabilities side of the balance sheet was a €165 billion or 32% rise in bank reserves (i.e. balances in current accounts and the overnight deposit facility) to a record €677 billion – 28% higher than the previous peak of €529 billion reached in June 2010.

According to some media reports, the high level of reserves – specifically the €412 billion deposited in the overnight facility at the end of last week – indicates that banks are “hoarding” liquidity injected by the ECB rather than lending to each other and the wider economy. This is wrong. While an individual bank can reduce its reserves by lending or buying assets, this is not true for the system as a whole – the cash is simply transferred to other banks (i.e. the institutions where the recipients of the lent funds or the sellers of the assets hold their accounts). Aggregate reserves can be reduced only by official actions – either the ECB taking steps to drain liquidity (e.g. restricting lending at refinancing operations or issuing bills / term deposits) or governments building up cash at the ECB by issuing more debt than needed to fund budget deficits.

The surge in reserves, therefore, is simply the counterpart of last week’s lending operation and carries no implication about current or future bank behaviour.

GDP was an estimated 0.5% below its third-quarter level in October, based on today’s news that services output fell by 0.7% between September and October together with earlier reports of changes of -0.7% and +0.6% in industrial production and construction output respectively. A quarterly fall in GDP, nevertheless, is not a done deal since monthly statistics are volatile and often revised heavily. The services PMI business activity index rose from 51.3 in October to 52.1 in November, suggesting a rebound in output.

Taking a step back, a 0.25% decline in GDP in the fourth quarter would imply full-year growth of 0.9% in 2011 – very disappointing relative to a consensus expectation of 2.1% at the start of the year. There are, however, two important qualifications.

First, part of the shortfall reflects a decline in North Sea production that should arguably be stripped out in assessing underlying economic performance. Gross value added excluding oil and gas is on course to rise by 1.3% in 2011 assuming a 0.25% fourth-quarter decline.

Secondly, there were two fewer working days in 2011 than 2010 – 251 versus 253, with one of the lost days due to the additional Royal Wedding bank holiday*. GDP statistics do not adjust for working days, implicitly assuming that lost output is recouped within the quarter or year. On an alternative assumption – admittedly equally arbitrary – that each lost working day leads to a permanent half-day loss of output, GDP growth in 2011 was depressed by about 0.4 percentage points (i.e. one day as a percentage of 253), implying a “true” rate of expansion of about 1.3%, or 1.7% excluding oil and gas. (The effect turns positive in 2012, when there are 252 working days despite an additional bank holiday to celebrate the Queen’s Diamond Jubilee.)

*The number of working days in 2011 was the lowest since at least 1967, according to the website www.work-day.co.uk. There have been two previous years since 1967 when the number of working days fell by two – 1977 and 2005. In both cases, GDP growth was lower than in the prior and following years.

Earnings downgrades by equity analysts slowed again in December, suggesting a further recovery in the G7 PMI manufacturing new orders index. The earnings “revisions ratio” – the difference between the proportions of estimate upgrades and downgrades, adjusted for seasonal variation – is only marginally below its long-run average and at a level consistent with a new orders reading above 50.


The US continues to lead the recovery in earnings and output momentum but Euroland is also improving at the margin, with a “surprise” rise in new orders in the December “flash” PMI manufacturing survey confirmed by a rebound in the revisions ratio.


Posts earlier in 2011 expressed concern about a Chinese “hard landing” but the judgement now is that risks are diminishing, reflecting a recovery in real money supply expansion. The Markit PMI new orders index remained weak in December but is not given weight here – the “official” PMI is more reliable and has displayed greater resilience, after seasonal adjustment. Korean exports to China ought to reflect any softness in domestic demand but picked up in the three months to November.

Banks borrowed €489 billion in the three-year operation but have repaid €307 billion of 12-month, three-month and seven-day money this week. The net increase in conventional lending, therefore, is €182 billion – smaller than the €278 billion resulting from the first 12-month LTRO in June 2009 but still substantial.

Banks have another chance to borrow for three years in February so there was no need to go “all-in” now.

The boost to bank reserves (i.e. balances in current accounts and the deposit facility) will be less than €182 billion to the extent that looser collateral requirements allowed banks borrowing under “emergency liquidity assistance” programmes to switch into the three-year operation – see previous post. The impact, however, should be at least €100 billion, implying that reserves will rise to well over €600 billion versus a previous record high of €529 billion in June 2010 (€512 billion last week).

The sustainability is open to question but the global economy is lifting in late 2011, as suggested by an earlier recovery in real money growth.

In the US, inflation-adjusted retail sales rose again in November while early December New York and Philadelphia Fed manufacturing surveys reported a further increase in order expectations, hinting at strength in ISM new orders.

While the Eurozone grapples with credit contraction, US bank lending continues to expand. Commercial banks’ loans and leases rose by 5.6% annualised in the three months to November, pushing the annual increase up to 2.2% – a three-year high.


Recent stronger demand for bank credit may partly reflect a rebuild of inventories, which should contribute significantly to fourth-quarter GDP expansion.


The inventory rebuild, in addition, may be boosting Asian exports, which were strong in November, with Taiwanese orders data today confirming an improvement.


It would be a stretch to suggest that the Eurozone is joining the party but last week’s flash PMIs seem consistent with an economy flatlining rather than heading into the abyss – at least for now. Today’s Ifo survey was also less dire than feared.


The onus is on central banks – specifically the ECB and PBC – to sustain global real money expansion in early 2012, especially with QE2-related US monetary buoyancy likely to fade.