Global Monthly - Will consumers be in time to save the eurozone recovery?

Global View: The stimulus taps are being cranked open. For Europe, is it too late?

The message from policymakers over the past month has been loud and clear, at least from the US and China: stimulus is coming. The Fed surprised most economists with a 50bp kick-off to its rate cutting cycle. And while the China stimulus measures announced this week are no bazooka, they are less piecemeal than in the past, suggesting that Beijing really means it this time. For the Fed, this is about keeping the good times going rather than being overly worried about the outlook at this point. For China, there is a greater sense of urgency, as successive smaller-scale measures not yet managed to break the negative feedback loop in real estate. What about the eurozone? The ECB has been more cautious in its support for the economy so far, held back by the legitimate fear that high wage growth might entrench higher inflation. This week’s PMIs may have shifted that calculus, with market pricing for a rate cut in October shooting higher in recent days, from only a 20% probability last week to a 2/3 probability at the time of publication. In this month’s Global View, we find that the chief culprit of the weak eurozone recovery has been the contraction in domestic demand. This in turn has been partly due to the chilling impact of high rates on lending. In that regard, a sharp rise in mortgage lending in recent months bodes well for resurgent consumption. A faster pace of rate cuts by the ECB, and stronger external demand – perhaps supported by this week’s China measures – would also help. But could the demand recovery come too late to prevent businesses from laying off workers, thereby scuppering the very recovery they’ve been waiting for? The coming months will be a critical phase for the eurozone recovery, and a pickup in consumption will be vital in avoiding another downturn.

European consumers have been in hiding. Could that be about to change?

After the energy crisis drove the longest sustained fall in real incomes since the eurozone sovereign debt crisis, things are finally looking up for European households. Real incomes have been growing on a sustained basis for almost a year now, and – excluding the volatile pandemic period – incomes grew at the fastest pace since 2001 in Q1 2024. Despite this, and puzzlingly, household consumption growth remains depressed. Services continues to do well, as the sector did even throughout the energy crisis, fuelled by a post-pandemic unquenchable appetite for restaurants and holidays. But goods consumption has confounded expectations for a recovery, essentially stagnating since the start of the Russia-Ukraine war in February 2022. At the same time, the household savings rate has jumped to 15.4% – the highest since at least 1999, if we exclude the pandemic period. Consumers are seemingly in hiding, reluctant to part with their newly regained purchasing power. What still holds consumers back, and what might coax them into spending again?

What’s holding consumers back?

The first and most obvious culprit is high interest rates. While the ECB has started lowering rates, the pace of rate cuts has been gradual so far, and at 3.5%, the main policy rate remains near the highest since the euro’s inception. High rates encourage households to save more and to borrow less. Looking at ECB flow of funds data – which closely tracks movements in the savings rate – we find that households have been borrowing considerably less rather than saving much more. Although time deposit flows have jumped sharply since rates rose, suggesting households have responded to higher rates, this has happened largely at the expense of lower overnight deposits. In the aggregate, deposits have grown only 2.6% over the past year, which is nothing out of the ordinary, and as a share of GDP deposits are back where they were before the pandemic. So, there does not seem to have been a shift in preference in how much cash households wish to hold. Based on our analysis, households have also not been paying off their mortgage debt more quickly, which is another effect that might be expected from high rates (1).

Borrowing less is the real reason for the savings rate increase

Rather, the main driver of the higher savings rate appears to be that households are simply borrowing much less. By far the bulk of lending to households is via mortgages, and mortgage lending collapsed when rates shot higher. At its trough in February this year, new mortgage lending (ex-refinancing) fell to the lowest level since 2016. The decline in lending also pushes the savings rate higher, as some of that lending is used for consumption, and the savings rate is ultimately a residual of income minus consumption.

The second and related factor is likely fear for the future following the financial trauma of the energy crisis. This is also likely why Europeans, unlike Americans (see US box), are not loading up on credit card or other forms of consumer credit. This is visible in consumer confidence. Having plunged to an all-time low in September 2022 – as the jump in energy bills sharply reduced purchasing power – consumer confidence has since slowly recovered, but remains below its historic average. With the Russia-Ukraine war still raging on Europe’s doorstep, amid a more generally volatile geopolitical backdrop, consumers may understandably worry that the next shock is just around the corner.

Taking a step back and looking at overall balance sheet metrics, households appear to have been on a relentless deleveraging since the onset of the European sovereign debt crisis some 13 years ago (see figure above; the short-lived pandemic spike in the debt ratio was mostly due to the fall in GDP). The combined impact of the pandemic and the energy crisis appears if anything to have accelerated this trend in recent years, with household debt as a share of GDP falling to a 20 year low in Q2 24.(2)

Is it safe to come out yet?

But there are tentative signs that the tide is turning. The most clearly visible sign is in new mortgage lending. As recently as Q1 this year, lending was still depressed at low levels. But in recent months, lending has suddenly surged, and as of July volumes were 58% above the February trough (see chart above-right). This has likely been helped by the combination of rising real incomes as well as the start of the ECB’s interest rate cuts, which is already leading to a turn in housing markets in a number of European markets. With ECB rate cuts expected to continue over the coming months, it seems reasonable to expect this jump in mortgage lending to be sustained. Historically, changes in new mortgage lending and housing transactions are a strong leading indicator for retail sales. This is corroborated by some of the underlying components of consumer confidence. For instance, the forward-looking question on major purchases over the next 12 months has surged recently. This makes intuitive sense: when people move house, they spend more on furniture and home improvement. Increased lending bids up house prices, and retirees who might be downsizing in a rising housing market may also use some of the proceeds of a home sale for extra consumption. These are just examples, but generally speaking, leverage in the economy can be a significant driver of activity. A reversal – or even slowing – in the deleveraging of recent years is therefore likely to have a major impact.

Curb your enthusiasm

A pickup in spending would come not a moment too soon for the eurozone recovery, which as this week’s PMIs confirmed, is coming dangerously close to stalling. While lukewarm external demand has not helped (see China box), the tepid nature of the recovery is chiefly due to weak domestic demand, which has technically been in recession, contracting -0.2% in Q1 and -0.4% in Q2. Despite only modest growth in global trade so far this year, net exports made significant positive contributions to GDP growth in the first half of 2024, adding 0.8pp to growth in Q1 and 0.5pp in Q2 (3). The blame for recent weakness in business surveys therefore lies to a large extent with spendthrift households. Germany’s struggling car industry is bearing the brunt of this, with car sales in particular performing very poorly recently. This is often attributed to the slowdown in the transition to EVs (partly due to Germany’s sudden withdrawal of subsidies last December), but sales of ICE cars have not meaningfully picked up in their place.(4)

The danger for the recovery is that, before a virtuous cycle of rising incomes, credit and consumption takes off, that businesses retrench to such an extent that this threatens the very recovery they have been waiting for. The most headline-grabbing sign of this has been Volkswagen’s historic move to close factories in Germany, which may be an ominous canary in the coalmine. Indeed, one of the most worrying aspects of the September PMIs was the decline in the employment sub-index, which for the eurozone fell clearly below 50 to 49.3, the lowest since the early pandemic period. While the cooling in the labour market is welcome from an inflation-fighting standpoint, in that it reduces upward pressure on wages, a more significant weakening in the labour market could bring the recovery in consumer confidence to an abrupt end. This could lead to a vicious cycle of weaker confidence, spending and employment, in contrast to the aforementioned virtuous cycle we are all hoping takes hold. Time is of the essence. The coming months will be a critical phase for the eurozone economy, and the recovery hinges on consumers coming out of hiding.

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Box 1: US consumption built on sturdy house of cards

The state of consumption in the US is markedly different from the European case. Goods consumption, closely related to retail sales, currently stands well above the pre-pandemic trend, following a boost in the level in March 2021 when consumers received a $1,400 government stimulus check and the economy re-opened. One might have expected this boost to be short-lived considering its origin. US consumers have however been able to largely maintain that level of goods consumption, which is especially surprising considering the fact that real wage shrank in the two years following the stimulus checks. Part of the resilience in goods consumption can be explained by a substitution effect away from services consumption, which took a hit during the pandemic, and is only now getting within a percentage point from its pre-pandemic trend. The subsequent further rise in real goods consumption since 2023 is supported by increases in real wages. Total consumption – goods and services – has stood above pre-pandemic trend since that initial stimulus check, and the gap is increasing rather than narrowing, reaching the highest level since November 2021 in the latest datapoint of this year.

How are US consumers paying for this? A first hint is in developments in the personal savings rate, which declined rapidly after the lockdowns, and has stood at low levels since. It is currently hovering near record lows at 2.9%. Accumulation of overnight and term deposits on households’ balance sheets is largely in line with this figure. Part of consumption is therefore driven by simply spending a larger part of disposable income. However, the acceleration in consumption growth starting in 2023 aligns poorly with the concurrent increase in the savings rate. The final piece of the puzzle can be found in household leverage. Households decreased their use of consumer credit during the pandemic. The steep deleveraging led to an equally steep decrease in consumption. Afterwards, households slowly increased their leverage again, supporting consumption growth after the stimulus checks and any excess savings ran out. The choice to save little and increase borrowing, is likely supported by high consumer confidence, which has been steadily rising since the second quarter of 2022, and only showed a minor decline in Q2 of this year. Consumer confidence in the US is strongly influenced by equity performance, and indeed, holdings in equities on household balance sheets increased by 13.7% over the last year, compared to only 2.8% in deposits, showing that at least some households are accumulating assets while also consuming significantly.

Overall, the data suggests that the high level of consumption may be quite fragile. It is fuelled by low levels of savings and consumer credit. The wealth associated with strong equity performance that boosts confidence is not equally spread. Buffers are thin. Credit card and auto loan delinquencies are already rising. Recent weakness in the labor market and the resulting risks to employment have the potential to very quickly alter the consumption path. (Rogier Quaedvlieg)

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Box 2: China’s private consumption cools after reopening rebound, showing need for active demand management

Following a rebound last year as China reopened after Zero-Covid exit, private consumption growth is cooling again this year. That implies that Beijing’s longstanding plans to boost the consumption share in GDP have not been very successful yet. The officially reported household consumption to GDP ratio is indeed low compared to developed economies (39% in 2023). That said, China’s consumption is generally assessed to be underestimated in the national accounts due to various data issues. Besides, an expenditure breakdown of China’s GDP is published only once per year, and not in every quarter as in other key economies. Therefore, China watchers typically look at retail sales (published monthly) to capture momentum in consumption. However, retail sales are not perfect in capturing overall household consumption either, as key consumption segments (for instance education, medical care, housing) are not included. Moreover, China’s retail sales also include some spending by government agencies, the military and some firms.

The property sector downturn is still a key driver of weakness in consumer confidence/spending

A post Zero-Covid exit boost in household consumption was visible in 2023 (annual growth of around 8%, from a very weak base in the broad lockdown year 2022). Retail sales also showed a pick-up towards the pre-pandemic trend in the course of 2023, but this movement has clearly gone into reverse this year, with annual growth falling back to 2.1% yoy in August 2024 (average 2023: 7.2% yoy). The main driver of the downturn in household consumption continues to be the negative feedback loop in real estate, with the failure of developers to finish construction projects in China’s presales system and shrinking housing wealth from the ongoing decline in home prices being key triggers (see our earlier coverage, for instance here and here). Consumer confidence dropped sharply back in early 2022, when Omicron lockdowns broadened and the property downturn started intensifying, but still stands around record lows. Consumers have propped up savings and are less willing to buy big ticket items, including new homes. The build-up of excess savings (estimated here via household bank deposits) accelerated during Zero-Covid and the intensification of the property downturn, stabilised during the 2023 reopening and picked-up again in early 2024. Cyclical developments such as a decline in real incomes and a deterioration in the labour market have also formed a drag on consumption this year.

Beijing’s support stance: Finally more focus on short-term demand management

Broadly speaking, Beijing’s policy stance over the past few years has focused mainly on the supply side, shaped by industrial policy considerations and a reorientation towards high-tech manufacturing and away from the (traditionally heavily leveraged) property sector. While this makes some sense from a long-term perspective, short-term demand management has played only a secondary role so far. Hence, measures taken to stabilise the property sector have been quite targeted/piecemeal, and have not really helped to break the negative feedback loop in real estate yet. With consumption (and private investment) weak and external risks broadening (slowdown US/Europe, more trade spats), we held the view for quite some time that more focus on short-term demand management was needed and likely. And indeed, on September 24th the PBoC announced a broad package with rate and RRR cuts, measures aimed at stabilising the property market and the installment of a fund to stabilise the stock market (also see China page in this Monthly). We expect this package to be followed by additional fiscal measures to support the property sector and domestic demand (confirmed by the Politburo on September 26th). Structural measures (e.g. strengthening the social safety net, revamp urbanisation), discussed during the CCP’s Third Plenum in July, would also help to bolster consumption over time. (Arjen van Dijkhuizen)

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(1) In some countries, for instance in the Netherlands, households are paying off more of their mortgages than in the past due to regulatory changes that have reduced the attractiveness of interest-only mortgages

(2) The silver lining of this deleveraging is that households are in a much healthier financial position. Indeed, a big part of the decline is likely policy-driven, as governments sought to reduce financial risk-taking post-GFC (see previous footnote).

(3) This was driven chiefly by strong growth exports rather than weak imports: exports added 0.6pp to Q1 growth and 0.7pp to Q2 growth, while imports added 0.3pp to Q1 growth but subtracted 0.2pp from Q2 growth.

(4) Consumers perhaps don’t want to buy something they know will be phased out, but this fits with the generally weak demand picture.