The second estimate of first-quarter GDP growth was unchanged at 0.3% (0.31% versus a preliminary 0.30% before rounding). Monthly output, however, rose by more during the course of the quarter than previously assumed, supporting the view here that GDP could post an outsized second-quarter increase.
Specifically, monthly GDP – based on output data for services, industry and construction, together accounting for 99.4% of GDP – grew by 0.1%, 0.7% and 0.2% in January, February and March respectively. The March reading was 0.35% above the first-quarter average – GDP will rise by this amount in the second quarter even if monthly output is static at the March level. Earlier data suggested a smaller carry-over effect of 0.25%.
As previously discussed, second-quarter GDP may also benefit from a rebound in construction output from weather-related weakness. A return to fourth-quarter activity – consistent with a rise during the second half of 2012 in construction new orders, which lead output – would boost GDP by about 0.3% relative to the March level. The combination of the carry-over and construction effects, in other words, could produce a 0.65% second-quarter GDP gain, before allowing for possible further growth in the rest of the economy.
The first-quarter GDP revision was accompanied by a first estimate of the GDP deflator (i.e. prices), which rose by a surprisingly strong 1.6%. Quarterly deflator changes are volatile but it is noteworthy that annual growth in current-price GDP jumped from 1.5% in the fourth quarter to 3.4% – the strongest since the third quarter of 2011.
A monetarist view is that this pick-up is being driven by an earlier recovery in broad money growth – annual expansion of M4 excluding money holdings of financial corporations has been moving up since the third quarter of 2011. The money supply typically leads economic activity by about six months and prices by about two years, suggesting an impact on current-price GDP after approximately 15 months. The rise in current-price GDP expansion in early 2013, in other words, is consistent with the late 2011 increase in money growth, which was sustained during 2012.
CPI inflation was expected to fall in April because of lower petrol prices and a favourable Budget base effect but the outturn of 2.4% was below a projection here of 2.6% (also the consensus forecast). The chart shows a revised profile incorporating the modest good news in today’s release. Inflation is projected to rebound to a peak of 3.3% in June before falling back to average 2.8% during the second half of the year.
Suggestions that today’s news marks the start of a new favourable trend are unconvincing:
Price expectations balances in business and consumer surveys are in the middle of their ranges in recent years, during which inflation has consistently overshot the 2% target.
Import prices have yet to respond fully to sterling weakness since late 2012.
Wholesale petrol prices are rising again. The drag effect on annual inflation will reverse even assuming stable pump prices.
A continued revival in economic momentum during 2013 may encourage more firms to raise prices, given modest spare capacity and below-average margins.
Stronger monetary growth since late 2011 should begin to exert upward pressure from late 2013, based on Friedman’s average two-year lead from money to prices.
The recent inflation fall, nevertheless, has improved economic prospects for the remainder of the year by giving a further boost to real money supply expansion.
The new CPIH inflation measure incorporating owner-occupiers’ housing costs fell to 2.2% in April. Such costs, however, are supposedly rising at an annual rate of only 1.0%. This is difficult to reconcile with other information: the CPI index of actual rents increased by an annual 2.6% in April, while the deflator for imputed rents in the national accounts climbed 5.7% in the year to the fourth quarter of 2012.
A post in December suggested that UK GDP would grow by about 2% in 2013. This was based partly on a simple forecasting rule-of-thumb that judges prospects for the coming calendar year to be “good” if both real money growth and share prices are higher than a year before. This condition was met at the end of last year for the first time since December 2005. Historically, growth has averaged 4.1% in years following such a signal – see the earlier post for details.
The current consensus is for growth of only 0.8% this year, according to the Treasury’s monthly survey of forecasters. 2% expansion is, on the face of it, out of reach. Current official statistics show that GDP in the first quarter was only 0.4% above the 2012 level. This implies that it would need to rise at a 4.1% annualised rate over the remaining three quarters to produce full-year growth of 2% (assuming an equal increase in each quarter).
Such arithmetic, however, is misleading because it ignores the potential for upward revisions to current official data. Quarterly GDP changes over 2009-11 (i.e. three years) have so far been revised up by an average of 0.18 percentage points since first reported. Assume that the initial estimates since the first quarter of 2012 are upgraded by the same amount. The first-quarter level of GDP would then be 0.8% above the 2012 level, rather than 0.4%. The economy would need to expand by “only” 3.0% annualised over the remaining three quarters to produce a full-year increase of 2%.
A further reason for retaining the 2% full-year forecast is the possibility of an outsized second-quarter GDP rise. Based on current official information, the March level of GDP was 0.25% above the first-quarter average*. Construction output was hit by poor weather in early 2013 and is likely to bounce back in the second quarter – a return to fourth-quarter activity would raise GDP by 0.35 percentage points relative to its March level. If the rest of the economy expands by 0.1% per month, GDP could rise by 0.8% this quarter (i.e. 0.25 carryover effect plus 0.35 construction boost plus 0.2 trend growth).
A 0.8% second-quarter gain, combined with the suggested upward revisions to earlier data, would imply a required growth rate of 2.6% annualised during the second half of 2013 in order to achieve 2% expansion for the year.
The suggested scenario would involve GDP growth of 2.6% between the fourth quarters of 2012 and 2013. This is not unrealistic: GDP rose by 2.4% in the year to the third quarter of 2010 and recent money supply expansion has been faster than in 2009-10.
*Based on actual industrial and construction data and the official assumption for March services output incorporated in the preliminary first-quarter GDP estimate.
Yesterday’s post cited improved investor sentiment as a reason for near-term caution on prospects for equities and other risk assets. A change in positioning as sentiment has shifted from excessive pessimism in late summer 2012 to moderate optimism now has been a key driver of recent market strength.
Equity hedge funds, in particular, now appear to have relatively high market exposure, suggesting that other investor groups will need to take up the baton if recent gains are to be extended. Exposure can be estimated by examining the sensitivity of the HFRX daily equity hedge return index to the MSCI World index. The beta measured over a 30-day rolling window rose from 0.13 in September 2012 to 0.48 last week – not far from a peak of 0.54 reached in June 2011 before a big decline in stocks.
The suggestion of bullish hedge fund positioning is supported by the latest Merrill Lynch survey, showing weighted net equity exposure of 45%, a seven-year high.
The indicators followed here were giving a positive signal for equities and other risk assets in late summer 2012:
Global real narrow money expansion was rising, suggesting an economic pick-up from late 2012 – see here.
A global “double-lead” indicator calculated here from OECD country leading indicator data had turned up, supporting the monetary forecast – here.
A large gap had opened up between global real money expansion and industrial output growth, implying “excess” liquidity available to flow into markets.
Central banks were easing policies and signalling more to come
Investors were unduly pessimistic about economic prospects and positioned defensively.
The current message from the same indicators is more ambiguous:
Global real money growth has moderated since late 2012 though remains at a level historically consistent with solid economic expansion.
The double-lead indicator has also declined – see below.
Global real money expansion remains above output growth but the gap has narrowed, suggesting a less favourable – but not unfavourable – liquidity backdrop.
Central banks are still easing but may scale back further stimulus in response to better economic news and market buoyancy.
Many but not all investors are optimistic and constructively positioned.
The judgement here, therefore, is that a reduction in exposure to equities and other risk assets is warranted currently and a shift to defence should be considered if the real money / output growth gap closes.
The global double-lead indicator fell further in March and is starting to diverge negatively from real money expansion – see chart. Real money has led recent industrial cycle turning points by an average of six months; the indicator has led by five months. The forecasting approach here places greater weight on monetary trends but both measures suggest that the acceleration phase of the cycle – during which equities typically do best – is ending.