Previous posts suggested that capital flowed back into Spain and Italy in September / October following the ECB’s backstopping of sovereign bond markets via the outright monetary transactions (OMT) programme. This suggestion is supported by Banco de Espana and Banca d’Italia balance sheet data for end-October, showing further declines in their Target 2 borrowing of €19.7 billion and €14.0 billion respectively. Outstandings, however, remain huge – a combined €647.2 billion.

The fall in their borrowing of €76.6 billion since end-August must have a counterpart in either a decline in lending into the system by the Bundesbank / other creditor central banks or increased borrowing by other debtors. The Bundesbank’s credit position fell by €56.0 billion in September but rebounded by €23.9 billion in October, according to the University of Osnabruck. Lending into Target 2 by the Finnish central bank, meanwhile, declined by €1.5 billion over the two months. This leaves €43.0 billion yet to be explained. (No other central bank has released end-October data.)

One possibility is that investors pulled money out of France in October in response to the tax-heavy austerity Budget unveiled in late September. (Banque de France Target 2 borrowing was negligible at €2.6 billion at end-September.) Alternatively, the large credit position of the Dutch / Luxembourg central banks may have fallen. It seems unlikely that borrowing by the “bailout three” central banks has risen significantly, given recent sovereign yield spread compression.

House price bears love the Halifax index, which fell by 2.8% in the year to October to stand 20.6% below its 2007 peak. Its gloomy message, however, is contradicted by four other house price indices, three of which have superior coverage.

House price indices weight together transactions either by value or volume. A value-weighted index (i.e. giving greater weight to more expensive houses) should be used if the focus of interest is the aggregate value of the existing housing stock. A volume-weighted measure (i.e. giving equal weight to expensive and inexpensive houses) is appropriate if the focus is the price of a “typical” house. (Other differences between indices are discussed in a previous post.)

The Halifax index is volume-weighted. So are the Land Registry (LR) and Nationwide measures. The LR index is superior since it uses a much larger sample size and includes cash- as well as mortgage-financed transactions. In contrast to the Halifax measure, it rose by 1.1% in the year to September (the latest available month) and is “only” 10.8% below its peak. The Nationwide index is weaker but its performance since the peak has been much closer to the LR than the Halifax measure – it fell by an annual 0.9% in October for a cumulative decline of 11.8%.

The two value-weighted measures are the LSL Acadametrics and Office for National Statistics (ONS) indices. The former is superior again because it is based on comprehensive LR data, whereas the ONS index uses a mortgage survey. Both measures are up over the latest 12 months – LSL Acadametrics by 2.2% to September and ONS by 2.1% to August – and are just 2.8% and 4.0% respectively below their peaks.

The Halifax index is a comfort blanket for crashistas who presumably sat out the entire housing market boom and now seek redemption by spinning tales of woe. Any analysis that references only this biased measure should be discarded. The true story of recent years is a sustained surge in prices followed by a partial correction and extended plateau. The best volume- and value-weighted measures are 42.6% and 57.5% respectively above their levels a decade ago – not bad after a five-year “bear market”.

Markets were seemingly unimpressed by the Bank of Japan’s decision last week to expand its asset purchase program (APP) by a further ¥11 trillion by the end of 2013. Relative to the size of the economy, however, securities purchases promise to be significantly larger than the Fed’s QE3 buying and – assuming unsterilised – will push bank reserves above the US level.

As of the end of October, the BoJ had bought ¥34.4 trillion of securities under the APP, introduced in October 2010. The new plan is to raise securities holdings to ¥66 trillion by the end of 2013, implying monthly purchases of ¥2.3 trillion, equivalent to $28 billion at the current dollar / yen exchange rate, over November 2012-December 2013. This compares with the Fed’s current QE3 run-rate of $40 billion per month.

The BoJ’s planned purchases by the end of 2013 amount to 6.6% of projected 2013 GDP. The comparable US figure is 3.4%, assuming that a $40 billion monthly buying pace is sustained throughout next year.
 
Bank reserves at the BoJ recently reached a record ¥42.2 trillion, up from ¥15.9 trillion when the APP was announced in October 2010 and comfortably above a prior peak of ¥33.8 trillion reached in 2004 – see chart. Assuming that forthcoming purchases are unsterilised and other influences net to zero, reserves will rise to ¥70.5 trillion by the end of 2013, equivalent to 14.7% of GDP*. On the same assumptions, US reserves will amount to 12.6% of GDP if QE3 is sustained at $40 billion per month.

The BoJ’s planned actions, in other words, are on a scale suggesting a significant impact on markets and the economy. Their effectiveness, however, could be enhanced by lengthening the maturity of securities purchases – longer-term bonds are more likely to be held outside the banking sector, in which case buying by the central bank results in a direct boost to the broad money supply in addition to a rise in bank reserves. The BoJ currently limits buying of government securities, which account for ¥58.5 trillion of the ¥66 trillion APP target, to Treasury bills and JGBs with a remaining maturity of less than three years.

*This is an illustrative projection rather than a firm forecast. Other changes on the BoJ’s balance sheet have resulted in APP buying to date being partially sterilised – reserves have risen by ¥23.0 trillion since October 2010 versus securities purchases of ¥34.4 trillion. However, further BoJ easing initiatives – such as the “fund-provisioning measure to stimulate bank lending” announced last week – could result in additional reserves creation.

Fourth-quarter loan officer surveys in the US and Eurozone released last week paint contrasting pictures. The net percentage of US banks tightening credit standards on loans to firms fell deeper into negative territory (i.e. more banks eased standards than tightened them, with the difference larger than last quarter). The corresponding Eurozone net percentage was positive and rose slightly; it remains, however, well below the first-quarter peak and is judged here to be consistent with the economy bottoming in late 2012.

The first chart below shows a long history of the US survey – note its suspension between 1984 and 1990. The series plotted is an average of the net percentages tightening credit to larger and smaller firms. A rise in this series above +20% warned of six of the seven recessions since the late 1960s. The exception was the 1981-82 “double dip”– arguably an extension of the 1980 recession rather than a separate contraction. (Output recovered temporarily in late 1980 / early 1981 after credit controls were removed before resuming a decline.)


Even at the height of the Eurozone banking crisis last winter, the US net tightening percentage reached only +4%, providing additional evidence against the recession forecasts of the Economic Cycle Research Institute and John Hussman*, among others. Excluding the distorted early 1980s experience, negative readings similar to those recorded recently have been associated with solid economic expansion.

The following chart compares US and Eurozone series, the latter again derived by averaging net tightening percentages for larger and smaller firms. The Eurozone series surged to +36% in the first quarter of 2012, confirming an earlier recession signal from a contraction in real narrow money. It fell back, however, to +9% in the second quarter in response to the ECB supplying unlimited term funding to the banking system before recovering to +14% in the latest survey – still below the +20% warning level.


The US and Eurozone survey responses are not adjusted for seasonal variation. The next chart incorporates an adjustment – the rise in the Eurozone net tightening percentage between the second and fourth quarters largely disappears. The suggestion is that the Eurozone credit crunch eased between the first and second quarters and conditions have since shown little change.


The “monetarist” view here is that the (real) money supply leads the economy while credit is a coincident indicator. Lending surveys are a short-term leading indicator – shorter than the money supply – because they give advance warning of credit trends. On this view, real money should predict credit conditions. The final chart shows the Eurozone net tightening percentage together with six-month real narrow money growth, plotted inverted. A leading relationship, as expected, is evident – in particular, real money contraction in early 2011 foreshadowed last winter’s credit crunch. The relationship suggests that coming lending surveys will show a fall in the net tightening percentage – assuming recent real money expansion is sustained.


The lending surveys, therefore, are consistent with the suggestion from real money trends that growth prospects remain better in the US – barring an unlikely fiscal cliff disaster – but that Eurozone activity is probably bottoming out in the current quarter ahead of a modest recovery in early 2013.

*Hussman maintains that a recession has started and suggests in his latest weekly comment that a recent rise in payroll employment will be revised to show a fall. He draws a comparison with 2001, when payrolls were originally reported to have risen by 105,000 over January-April as a recession was starting; the current vintage of data shows a  loss of 262,000. The alternative household survey jobs measure, however, signalled in real time that the labour market was weakening, falling by 704,000 over January-April 2001. There is no such divergence in recent data: a payrolls increase of 319,000 in September-October is “confirmed” by a 1,027,000 gain (admittedly distorted) in the household survey measure.