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Analysis
As divergence continues

As divergence continues

That the US would do better than the euro area in 2012/2013 was already clear
What, if anything, will the EA do about it?

by Gabriel Stein, OMFIF Chief Executive

Tue 7 Aug 2012

That the US would do better than the euro area (EA) in 2012/2013 was already clear – but what, if anything, will the EA do about it?

Neither the Fed, nor the European Central Bank (ECB) pay much attention to money. In the case of the Fed, this is in theory as well as in practice, while the ECB in theory is a monetarist central bank which in practice ignores monetary data. This is a point we have made in the past and will return to in the future. (See, e.g. a forthcoming OMFIF Commentary by Steve Hanke on monetary developments in the US.)

However, both central banks pay attention to credit. The recent bank lending surveys for the third quarter (the ECB’s EA Bank Lending Survey was published 25 July, the Fed’s Senior Loan Officers survey on 6 August) are therefore presumably required reading by decision makers in Washington and Frankfurt as well as the regional central banks. From a euro area perspective, they do not make encouraging reading. Yes, the balance of banks intending to tighten loan standards over the next three quarters is roughly stable for housing loans and falls for consumer credit; but it has risen for corporate lending.

(missing charts)

Given that the outlook for a surge in housing loans in any EA country is limited (either because they are still emerging from a housing bust or because the underlying conditions for a housing boom are absent), corporate lending is at this stage likely to be more important than household. This being the case, banks’ opinion on loan demand also makes distressing reading: demand for all three loan categories is forecast to weaken, particularly disconcerting in the case of corporate loan demand, which in the previous survey was forecast to expand (but didn’t, judging by the answers on demand over the past three months).

Both tightening of standards and loan demand are better than a year ago. But, significantly, lending standards, on balance, continue to tighten and loan demand, on balance, continues to weaken, showing declining confidence. This is not surprising; however, the amply-evidenced incapacity of EA politicians and central bankers to follow up promises with action, is unlikely to boost the sentiments of either companies or households.

The Fed’s survey, by contrast, shows some encouragement. The two surveys are not exactly comparable. But, crucially, loan standards are generally easing and loan demand is at worst flat, at best rising somewhat. This is true for commercial and industrial (c&i) loans as well for housing loans – though not as much for consumer credit.

The Fed data comes in the wake of money and credit data published at the end of last week, which show overall loans from commercial banks by end-July at a post-crash high and within striking distance (2.9% or 200 billion dollars) of their pre-crash peak.

(missing charts)

US money supply is already growing at a modest, but encouraging 4.2% (year to June, M3 series re-created by the author); while ECB money supply is barely growing by 3%. On this basis, you would expect the ECB to be feverishly working on efforts to boost money and credit growth; while the Fed could afford to be (very slightly) more complacent. Yet what is the reality? The Fed is clearly preparing for QE3 (the efficacy of and need for which can be discussed); while the ECB is engaging in its usual pattern of speaking loudly and carrying a twig.

It was already clear that the growth outlook was diverging, with the US likely to see positive, if modest, growth in 2012 and 2013, while the euro area is likely to see another recession. The money and credit data merely confirm this view. The real question is, what, if anything, will be done.

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