Key UK money and credit measures continued to grow solidly in October, sending a positive message for economic prospects and supporting the case for an early rate rise.
The Bank of England’s broad money measure, M4ex, rose by 0.4% in October, pushing annual growth up to 4.5%, the fastest since January – see first chart.
The rate of increase of M4ex has been restrained recently by 1) a fall in financial sector deposits, which probably has little relevance for economic prospects, and 2) a switch of household deposits into National Savings (NS), which are not included in M4ex. A better guide to the availability of liquidity to finance private sector spending is the sum of M4 money held by households and private non-financial corporations (PNFCs) – i.e. “non-financial M4” – and outstanding NS. This increased by 0.6% in October, pushing annual growth up to 6.4%, the fastest since May 2008 – first chart.
The velocity of circulation of this measure has been broadly stable in recent years – see previous post. If velocity were to continue to move sideways, sustained 6% plus growth would be reflected, in time, in an equal rate of increase of national income. This, in turn, would imply inflation of 3.5% plus, assuming 2.5% trend output expansion. The MPC is unconcerned about, or oblivious to, this risk, judging from recent communications*.
The rise in broad money growth has been concentrated in the corporate sector, with annual growth of PNFC M4 rising to 12.7% in October, the fastest since June 2007.
Narrow money continues to expand more strongly than the broader aggregates. Non-financial M1 (i.e. currency in circulation and sight deposits of households and PNFCs) rose by 0.9% in October, lifting annual growth to 7.4%. This is, however, well down from a peak of 12.0% reached in October 2013.
Credit expansion is gathering pace, with the annual increase in M4ex lending up to 3.3% in October, the fastest since April 2009. Non-financial lending growth (i.e. to households and PNFCs) is lower, at 2.6%, although such lending has risen more strongly recently – at an annualised rate of 3.8% in the latest three months.
Of the various measures, real (i.e. inflation-adjusted) non-financial M1 has the best record as a leading indicator of the economy, accelerating before rises in GDP growth and contracting before recessions – second chart. Its six-month rate of increase has been little changed over the past year, consistent with GDP continuing to expand by about 2.5% per annum. Recent stronger broad money growth, however, suggests upside risk to this forecast.
*The word “money” did not appear in either the November or August Inflation Reports.
The Korean economy is often a bellwether of global trends, reflecting its openness* and wide-ranging industrial activities spanning electronic equipment, vehicles and capital goods. The Federation of Korean Industries (FKI) expected business conditions indicator rose sharply in November, with strength focused on manufacturing, particularly exports. This suggests that global trade and industrial output are regaining momentum, in line with a forecast based on monetary trends – see chart.
China is Korea’s largest export market, accounting for 26% of shipments in 2014 (versus 11% for the US). The rise in Korean optimism may indicate that Chinese demand is beginning to respond to monetary / fiscal policy easing.
*Exports of goods and services = 51% of GDP in 2014.
Whatever happened to the ECB’s “monetary pillar”? Annual growth of broad money M3 rose to 5.3% in October, comfortably above the central bank's 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 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 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.
ECB doves argue that additional action is required because headline inflation remains close to zero, GDP growth fell back last quarter and external downside risks have risen, reflecting China’s slowdown. These reasons are unconvincing.
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.