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Keep an eye on the tightening

15 June 2018 by Gary Kirk

In recent months we have discussed with investors the importance of trying to ascertain our whereabouts in the credit cycle, the importance of both central bank and commercial bank tightening as barometers in this regard. This is critical because bank tightening directly impacts the economy and is a consistent precursor to periods of recession. It therefore follows that keeping abreast of any adjustments to bank lending practices or changes to tightening momentum are fundamental in investment decision making.

Following on from our recent comment on the level of Italian BTPs and how this has a potential to impact the transmission mechanism, it is interesting to note the subtle but important changes that have been applied elsewhere across the global economy. Slowly but surely, tightening is being applied.

Quite literally on the other side of the planet, the Australian central bank has been reluctant to raise rates due to benign economic data. However, low interest rates have helped fuel a seven-year inflation bubble in the country’s housing market, particularly along its Eastern coastline, which has resulted in a ‘Royal Commission’ looking at levels of domestic debt and affordability. In anticipation of regulatory changes being imposed, the domestic banks have all tightened their lending criteria, with far more stringent rules being applied to loans and mortgage applications.

Earlier this week a proposal from the Banque de France (BdF) led the High Council for Financial Stability to inform the French commercial banks it was going to impose the so-called Counter Cyclical Buffer (CCyB), in order to make the banking system more resilient to any future economic stress. This is the first time the BdF has applied the buffer since it was introduced under Basel III in 2016, and even though it has only been raised from 0% to 0.25% with the banks given until July 2019 to comply, it is a macroprudential tool that will filter through as a degree of tightening. This action from the French follows the application of the CCyB already underway in Sweden, Switzerland, Hong Kong and of course the UK, where in June 2017 the BoE gave banks 18 months to apply a buffer of 0.5%.

Monetary policy influences the real economy through multiple channels. Movements in central bank discount rates understandably get the vast majority of investor and media attention, but we feel strongly that keeping on top of the less glamorous detail is extremely important. To date the tightening has been very subtle and we expect the momentum to be very orderly over an extended period of time, but it does appear to be underway and we will continue to monitor it closely as we know that ultimately a tightening of financial conditions precedes every recession.

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