EU money supply shrinks as ECB turns off taps

FRANKFURT, Oct 01 (Reuters): The amount of money circulating in the euro zone shrank by the most on record last month as banks curbed lending and depositors locked up their savings, two tangible effects of the European Central Bank's fight against inflation.
Faced with the highest inflation rates in its nearly 25-year history, the ECB has turned off the money taps by jacking up interest rates to record highs and withdrawing some of the liquidity it pumped into the banking system over the previous decade.
The ECB's latest lending data on Wednesday showed this sharp increase in borrowing costs was having the desired effect and may fuel a debate over whether such a brisk tightening cycle may even push the 20-country euro zone into a recession. A measure of money supply comprising just cash and current account balances shrank by an unprecedented 11.9% in August as bank customers switched to term deposits now offering much better returns as a result of the ECB's rate hikes.
The ECB's own research shows that a drop in this gauge of money, once it is adjusted for inflation, is a reliable harbinger of recession, although board member Isabel Schnabel said last week it was more likely to reflect a normalisation in savers' portfolios at this juncture.
A broader measure of money that also includes term deposits and short-term bank debt also declined by a record-breaking 1.3%, showing some money was leaving the banking sector altogether-likely to be parked in government bonds and funds.