This morning’s quarterly bank lending survey capped off a series of indicators with a bleak message for the Eurozone economy. Almost all signs suggest that Europe continues to spiral downwards.
The lending survey, compiled by the European Central Bank (ECB), is one of the best leading indicators of all because it tells us about the critical credit link in the economy. Here’s my explanation for its importance from a post last month:
In a recession, this survey is like a quarterly and economic version of Groundhog’s Day. If it shows lending standards are still tightening, then expect “winter” to continue, because it’s folly to think economies will recover. Economies rise and fall with the rise and fall of credit, and if bankers tell you credit expansion isn’t happening, then economic expansion isn’t happening either. It’s really that simple. This is arguably the best leading indicator of all, even though it’s rarely noticed. For those optimistic forecasters who keep expecting a recovery and getting it wrong, their errors are probably best explained by not giving enough weight to lending standards.
In the Eurozone today, tight credit is part of a vicious circle that includes business retrenchment, weakening demand, job cuts and falling incomes. And the scariest thing about the circle is that it feeds on itself – each part reinforces the other parts. It won’t go on forever, but we need to see some improvement in the leading edge of the economy before we can expect it to end.
Lending standards are one place to look for such improvements. Others include house prices and construction, real wages and incomes, and corporate profits. We’ve seen new data in each of these areas over the past month, and here’s what it’s telling us:
Although there was some improvement in the first quarter, the percentage of banks that tightened standards for both business loans and house purchases continued to outnumber the banks that loosened standards. Together with a rise in non-performing loans as economies weaken, the survey suggests that banks aren’t yet ready to lead the Eurozone out of recession. And neither are businesses and house shoppers: another section of the report shows that the net percentage of banks that are seeing increasing (versus decreasing) demand for credit is -24% for business loans and -26% for housing loans.
House prices and construction
Housing and construction nearly always rise and fall in advance of other sectors in the economy. While there are sharp differences within the Eurozone, aggregate data shows these sectors in clear Tom Petty territory – they’re free fallin’.
Real wages and incomes
In the later stages of recession, real wages typically begin to grow before coincident indicators such as production. The labor cost index released last month showed that we haven’t yet seen such a pick-up. And household disposable income is especially weak, reflecting cuts in hours worked as well as employment.
Although company reports are more timely, Eurostat’s figures for gross operating surplus (GOS) are worth watching as a proxy for aggregate corporate profits (before depreciation and amortization). Data released this month showed the annual growth in GOS slipping into negative territory.
In addition to the indicators above, two other places to look for a possible boost are the external sector and government spending. But an export-led recovery seems doubtful as long as economies in other regions remain subdued, at best, and the Euro continues to lose ground in the global currency war. Public spending in the Eurozone was essentially unchanged in the last half of 2012, and its flat trend is likely to continue this year.
Where does this leave us?
As far as the most telling leading indicators, those that can be directly manipulated through monetary policy are the only ones pointing to a possible end to the vicious circle. In other words: interest rates and equity markets.
But low policy rates, tightening bond spreads and occasional equity market rallies seem overwhelmed by the bigger picture. Until we signs of strength in at least one or two of the leading indicators discussed here, bet on the recession to continue.