Whatever happened to the ECB’s “monetary pillar”? Annual growth of broad money M3 rose to 5.3% in October, comfortably above the 4.5% “reference value” – the rate “deemed to be compatible with price stability over the medium term”. Yet ECB President Draghi seems determined to push through a further easing of monetary policy at next week’s Governing Council meeting.
Bank lending growth remains subdued but published ECB research shows that money leads credit rather than vice versa. October lending figures were encouraging, with loans to households and non-financial corporations (NFCs), adjusted for sales and securitisation, rising by 0.3% on the month, pushing annual growth up to 1.0%, the fastest since January 2012 – see first chart.
The monetary measure with the most impressive leading indicator properties, according to the ECB research, is non-financial M1, comprising currency in circulation and overnight deposits of households and NFCs. This continues to rise strongly, with a 1.1% October gain pushing annual growth up to 10.9%, close to a recent 11.0% peak reached in July.
Mr Draghi’s dovish majority of French / Belgian and “Southern Comfort” central bankers argues that additional easing is required because headline inflation remains close to zero, GDP growth fell last quarter and external downside risks have risen, reflecting China’s slowdown. No element of this case is convincing.
Commodity price weakness has obscured a significant pick-up in core inflation: the ECB’s seasonally-adjusted consumer price index excluding food and energy rose at a 1.4% annualised rate in the six months to October versus 0.8% in the prior half-year – second chart.
GDP expansion of 0.3% in the third quarter, down from 0.4% in the second, may well be revised up when a figure for fast-growing Ireland is incorporated. Even 0.3%, however, is above the IMF’s estimate of trend growth of 1.0% a year*, or 0.25% per quarter.
Downside China risk, meanwhile, was at a maximum a year ago when real narrow money was contracting. With money now surging and fiscal policy in overdrive, a positive surprise is more likely.
Chinese narrow money growth has rebounded strongly in recent months, suggesting better economic prospects – see previous post. A claim has been made, however, that the surge in the official M1 measure mainly reflects a temporary impact from the local government debt swap programme, implying little significance for the economy or markets. The analysis below does not support this claim.
The debt swap programme involves provincial governments issuing bonds and passing the proceeds to related local government financing vehicles (LGFVs) in order for them to repay bank debt. The claim is that the last stage of this process has yet to occur, so LGFV money holdings have been temporarily inflated. LGFVs are classified as part of the corporate sector in the monetary statistics while corporate demand deposits account for most of the recent M1 strength.
Annual growth of corporate demand deposits rose from 4.6% in June to 16.2% in October – see chart. It is not possible to identify the contribution of LGFV deposits to this surge but a separate series is available for demand deposits of non-financial enterprises, which exclude LGFVs and account for about half of the corporate total. Annual growth in these deposits rose from 2.0% to 18.3% between June and October. It is wrong, therefore, to state that most of the increase in corporate demand deposit growth has been due to LGFVs.
The remaining segment of corporate demand deposits (i.e. the total minus deposits of non-financial enterprises) covers the LGFVs and other government-linked bodies, as well as private financial institutions. Annual growth in this segment rose from 7.1% to 14.2% between June and October. This may reflect monetary and fiscal policy easing as well as the posited debt swap effect.
As previously discussed, the Chinese M1 definition, unusually, excludes household demand deposits, which should be taken into account when assessing narrow money trends. (They are added to the official series to create the “true M1” measure followed here.) Annual growth of such deposits rose from 0.2% to 8.9% between June and October.
To summarise, the narrow money surge reflects stronger growth of household as well as corporate demand deposits while most of the latter pick-up is unrelated to the debt swap programme. Narrow money has been a good leading indicator of the economy in recent years and there is little reason to doubt the current positive signal.
The Chancellor defied claims that he was “boxed in”, finding room to abandon cuts to working tax credit, loosen the squeeze on departmental current spending and boost capital spending plans, while reducing cumulative borrowing and maintaining a forecast surplus of £10 billion in 2019-20.
He was able to achieve this feat partly thanks to helpful decisions by the Office for Budget Responsibility and the Monetary Policy Committee. The OBR revised up its receipts forecast significantly, citing recent higher-than-expected income / corporation tax revenues and “modelling changes”. Projected net interest payments, meanwhile, have been cut to reflect lower market rates and the MPC’s decision to delay a reversal of QE until Bank rate reaches 2%.
The Chancellor, interestingly, chose to give himself additional spending room by raising extra revenue via a new apprenticeship levy on companies, a rise in stamp duty on buy-to-let property and second homes, and an increase in council tax.
While spending plans are less restrictive, the overall pace of fiscal tightening is little changed from the July Budget. Cyclically-adjusted net borrowing is projected to fall by an average of 1.0% of GDP a year over the next four years, slightly more than the 0.9% of GDP forecast in July.
Global monetary trends have been signalling a revival in economic momentum in late 2015 and respectable growth in the first half of 2016 – see previous post. The lift was expected to be driven by Europe and Asia, with relatively weak US money growth suggesting moderate economic expansion at best.
Incoming news remains consistent with this scenario. November “flash” PMI surveys surprised positively in the Eurozone and Japan but negatively in the US. The German Ifo survey was strong, confirming a bullish signal from trucking activity – see Friday’s post. Export order responses in the German / Japanese surveys, meanwhile, suggest that global trade is reviving.
US indicators are mixed rather than signalling weakness. On the positive side, truck sales remain strong and single-family housing permits rose to a new recovery high last month. While the PMI was softer, the Philadelphia Fed manufacturing survey recovered in November and is often a better guide to the national ISM result.
Global money trends, on the analysis here, are giving a reassuring message but are not outright strong. Claims have recently been made, however, that global real or inflation-adjusted money growth is at its highest level, excluding the 2008-09 period, since the late 1980s. Such claims are dubious.
The chart shows annual rates of change of real (i.e. consumer price index-deflated) narrow / broad money and bank lending in the G7 and seven large emerging economies (the "E7"). Real narrow money (M1) growth is around the middle of its range since 2010. Real broad money (M3) growth, similarly, is below its peak in early 2013 and significantly lower than in 2006-07.
One recent report stated that global real M1 growth had risen to an annual 11%, compared with a 7% estimate here for the G7 plus E7. The former figure is difficult to reconcile with national data. On the latest numbers, real M1 growth is 12.5% in China, 11.8% in the Eurozone, 5.7% in the US and 5.4% in Japan. While real money is rising significantly faster in some emerging economies (Korea, Mexico), it is contracting in others (Brazil, Russia). To generate a “global” estimate of 11%, it is necessary to assign much higher weights to China and Euroland than their shares of world GDP, while omitting E7 laggards*.
*The G7 plus E7 aggregates are constructed by combining monthly percentage changes in national series using GDP-based weights. This approach is appropriate if 1) the focus of interest is G7 plus E7 GDP and 2) national GDP prospects depend on national money trends. The alternative of adding up currency-adjusted national money supply levels may be misleading because of large cross-country differences in liquidity preference: for example, the ratio of M1 to GDP in China is more than three times that in the US, so the adding-up approach assigns a much larger weight to money growth in China than the US.
The "toll index" produced by the IZA research institute measures domestic trucking activity using data from the system that levies road tolls. Unsurprisingly, it is usually a good coincident indicator of industrial activity. The chart compares year-on-year percentage changes of industrial output and aggregate kilometres driven, using monthly data unadjusted for seasonals. The toll index has diverged positively from industrial output in recent months and rose sharply further in October (October output will be released on 7 December). Trucking activity has presumably been boosted by a need to transport supplies to incoming refugees but this should still signal a stronger economy, to the extent that the supplies are sourced domestically.