The preliminary first-quarter GDP estimate to be released on Friday 28 April may show a quarterly increase of only 0.3-0.4%, while revised data to be issued in late May could upgrade the fourth-quarter rise from 0.7% to 0.8%. The 8 June general election, therefore, may take place against the background of a halving of reported quarterly growth.
A post in early March suggested that GDP would rise by 0.4-0.5% in the first quarter – below a Bank of England staff projection of 0.6% at the time of the March MPC meeting. Subsequent data have, on balance, been weaker than expected then. Services turnover, in particular, was soft in February, suggesting little if any growth in output – see chart. Retail sales volume, meanwhile, fell by 1.8% between February and March, implying a negative impact of 0.1% on monthly GDP. (The sales volume series is used to measure retail distribution output, which has a 5.6% weight in GDP.)
Fourth-quarter GDP growth is currently estimated at 0.7%, with a revision scheduled to be issued on 25 May. A recent upgrade to quarterly services turnover growth suggests that the increase in services output will be revised higher, raising the possibility that GDP growth will move up to 0.8%. (Note that official data already show non-oil GDP growth of 0.8% in the fourth quarter.)
Previous research here suggested that GDP numbers have little impact on voting intentions – the key economic drivers were found to be average earnings growth, the unemployment rate, retail price inflation, house price inflation and Bank rate. A big GDP slowdown, however, would garner media attention and could fuel some voters’ suspicions that Prime Minister May has called an early election in anticipation of Brexit-related economic weakness later in 2017 and in 2018.
Chinese monetary trends signalled current economic strength and now suggest a modest loss of momentum during the second half of 2017.
First-quarter and March economic data released yesterday were mostly stronger than expected. Annual growth of nominal GDP rose to 11.8% last quarter, the fastest since 2012 and up from a low of 6.4% at end-2015. The recent surge has been driven by the GDP deflator but real GDP growth of 6.9% was above the consensus forecast and a 6.5% full-year official target – see first chart. Annual industrial output expansion, meanwhile, climbed to 7.6% in March, the fastest since 2014, despite a slowdown in auto manufacturing following a partial reversal of the 2015 sales tax cut on smaller vehicles.
These robust results are consistent with monetary strength last summer. The preferred narrow and broad monetary aggregates here are “true” M1 and M2 excluding financial corporations' deposits respectively. True M1 includes household demand / temporary deposits, which are relevant for assessing consumer spending prospects. (The official M1 measure includes only corporate deposits.) Financial deposits within M2, meanwhile, have been highly volatile in recent years but appear uncorrelated with economic developments.
Annual growth of the two preferred measures rose significantly between mid-2015 and summer 2016, signalling that nominal GDP expansion would pick up strongly into the first half of 2017 – second chart. True M1 growth peaked in August 2016, at 22.1%, and growth of M2 ex. financial deposits in November, at 13.4%. The latest figures, for March, are 16.3% and 11.4% respectively. The lag between money growth and nominal GDP growth turning points has been variable in recent years but a reasonable expectation is that annual nominal GDP expansion is at or close to a peak and will moderate during the second half of 2017.
The two money growth measures have retraced less than one-third of their rise over 2015-16, suggesting a minor decline in nominal GDP expansion, which should remain well above the low reached in late 2015.
Economic activity prospects are related to real (i.e. inflation-adjusted) rather than nominal monetary trends. The third chart shows six-month rates of change of industrial output and narrow / broad money deflated by consumer prices (seasonally adjusted). The real money growth measures have fallen significantly since summer / autumn 2016 but are close to their averages since 2010, consistent with a moderation in economic expansion rather than a return to sub-par performance. The typical nine-month lead suggests that coincident economic news will remain robust into mid-2017.
UK annual consumer price (CPI) inflation was stable at 2.3% in March but remains on course to move above 3% in the second half of 2017, implying a significant overshoot of the Monetary Policy Committee’s central forecast (showing inflation of 2.6% and 2.7% in the third and fourth quarters respectively).
CPI inflation was suppressed by a 23% year-on-year fall in air fares due the later timing of the Easter holiday this year compared with 2016. This effect subtracted 0.2 percentage points from the headline rate but will reverse in April.
The forecast of a move above 3% is based on “core” inflation – defined here as the annual CPI increase excluding energy, food, alcohol, tobacco and education, and adjusted for VAT changes – rising to about 2.5% by late 2017 and the headline / core gap climbing to more than 1 percentage point. The air fares effect resulted in the core rate retreating from 1.9% in February to 1.7% in March – see first chart. Seasonally-adjusted core prices, however, rose at a 2.5% annualised rate in latest three months from the prior three, consistent with the forecast – second chart.
The headline / core gap, meanwhile, increased to 0.6 percentage points in March, the highest since 2013, and the lagged relationship with sterling commodity prices suggests that it will peak well above 1 percentage point later in 2017 and remain elevated into 2018, unless commodity prices weaken or the exchange rate rallies significantly – third chart.
A post last month argued that inflation is rising in lagged response to a significant increase in monetary expansion between 2011 and late 2016. The fall in the exchange rate has been part of the “transmission mechanism” from loose money to faster price rises, rather than being a primary driver. The historical evidence is that money growth peaks lead core inflation peaks by between two and three years. Assuming that annual broad money growth topped out last autumn*, the suggestion is that inflation will remain under upward pressure through late 2018, at least.
*Annual growth of non-financial M4 peaked at 6.8% in September 2016, falling to 5.4% in February 2017 – see previous post.
Global economic growth remained robust in early 2017 but monetary trends and leading indicators suggest that strength will fade from the spring. Central banks may continue to withdraw policy stimulus despite slower economic momentum because of late-cycle inflationary pressures. Lower real money growth implies a less favourable liquidity backdrop for markets, while earnings may fall short of expectations as the global economy cools.
On our calculations, GDP in the G7 major economies and seven large emerging economies (the “E7”) rose at a 2.8% annualised pace in the fourth quarter of 2016 after a 3.2% third-quarter gain. Average growth of 3.0% over the second half was the fastest since the second half of 2014. Business surveys signal continued strength in early 2017: J P Morgan’s global all-industry purchasing managers’ output index rose further between the fourth and first quarters.
Global economic acceleration was predicted by monetary trends. Our key global forecasting indicator is the six-month growth rate of real (i.e. inflation-adjusted) narrow money in the G7 plus E7 economies. Narrow money comprises currency in circulation and demand deposits – forms of money most closely related to economic transactions. Turning points in this indicator have consistently led turning points in G7 plus E7 industrial output growth over the past 50+ years, typically by between six and 12 months.
Real narrow money growth peaked in August 2016 at its fastest pace since 2009, suggesting that economic momentum would rise into spring 2017, allowing for an average nine-month lead. The subsequent monetary slowdown was exaggerated by India’s “demonetisation” programme, which resulted in narrow money M1 plunging by 30% between October and December. We have attempted to adjust for this distortion by recalculating our real money growth measure holding Indian M1 stable at its pre-demonetisation level. The adjusted measure fell sharply in late 2016 / early 2017, reaching an 18-month low in February – see first chart. Four-fifths of the decline in the measure since August 2016 has reflected weaker nominal narrow money expansion, with the remaining one-fifth due to higher inflation.
Our forecasting process seeks confirmation of monetary signals from a non-monetary composite leading indicator for the G7 plus E7 economies, derived from OECD country leading indicator data. This indicator combines a wide range of economic and financial series that have led activity fluctuations historically. Its average lead time at turning points is shorter than for real narrow money – typically four to five months. Six-month growth of the indicator plateaued in February, while one-month growth fell for a second month – second chart. This behaviour is consistent with the suggested scenario of global economic momentum slowing from a spring peak.
Real narrow money growth has fallen by varying amounts across the major economies. Weakness has been most pronounced in the US, suggesting that GDP expansion will fall short of Federal Reserve and consensus expectations – third chart. The UK has also slowed sharply recently. Growth, by contrast, is holding up in Euroland and Japan, and remains high in China. Brazil and Russia are bucking the trend, with real money growth reviving as inflation falls and policy eases.
With monetary trends giving mixed signals across countries, our base-case scenario is for a moderate global economic slowdown rather than significant weakness. This would be consistent with our economic cycle analysis, which suggests that the US / global stockbuilding and business investment cycles will remain in upswings through 2017. Such a scenario, however, requires our global adjusted real narrow money growth measure to stabilise or recover from its current position near the bottom of its post-crisis range – first chart.
Early- or mid-cycle economic slowdowns usually generate a swift central bank response and are associated with falling government bond yields and commodity price weakness. Late-cycle slowdowns, by contrast, are often accompanied by a rise in inflation due to tight labour markets, capacity constraints and productivity slippage, delaying policy relief and yield declines. The G7 unemployment rate is lower than at the peaks of the last two economic cycles – fourth chart. Upward pressure on wage growth and core inflation may keep central banks on a tightening tack despite softer economic data, with negative implications for equities.
Our analysis of data since 1970 indicates that major equity market declines have usually been preceded by one or more of the following conditions: 1) G7 annual real narrow money growth falling below 3%; 2) real money growth falling below industrial output expansion; 3) real money growth falling by 3 percentage points or more within six months. Conditions 1) and 2) are unlikely to be triggered soon but real money growth has declined from a peak of 8.6% in October 2016 to 6.5% in February; a further fall to 5.5% or lower by April, therefore, would meet condition 3) and warrant shifting to a defensive investment stance.
Relative real narrow money trends argue for overweighting emerging versus developed markets, and EAFE markets versus the US. E7 real money growth, adjusted for India’s demonetisation, remains above the G7 level, a condition associated with emerging markets outperforming on average historically – fifth chart. A sustained shortfall of US real money growth relative to other developed economies, meanwhile, would be reminiscent of the mid 2000s, when EAFE stocks outpaced the US market, partly reflecting a weakening US dollar.
Our previous quarterly commentary questioned consensus bullishness on the dollar on the grounds that a record capital outflow from Euroland, Japan and China had boosted the US currency in 2016 but was likely to slow in 2017. Recent data are consistent with this hypothesis and the reversal in capital flows may extend if US economic growth weakens relative to the rest of the world, as suggested by monetary trends. A recovery in the renminbi is possible in response to a rise in Chinese / US interest rate differentials in the first quarter and as Chinese policy shifts towards promoting a firmer exchange rate to defuse trade tensions with the US administration.
UK monthly sectoral output numbers suggest that quarterly GDP growth will slow to 0.4-0.5% in the first quarter from 0.7% in the fourth quarter. GDP price data, meanwhile, confirm a pick-up in domestic inflationary pressures, with the annual rise in the GDP deflator unrevised at 2.8% in the fourth quarter. The current account deficit fell sharply last quarter, reflecting stronger trade performance in both goods and services and a further fall in net income paid abroad.
Highlights of today’s batch of data releases include:
GDP fell by 0.2% between December and January to stand 0.3% above the fourth-quarter level. The decline spanned sectors, with services, industrial and construction output down by 0.1%, 0.4% and 0.4% respectively. The soft start to the quarter suggests downside risk to the Bank of England staff “nowcast” of 0.6% growth in the first quarter at the time of the March MPC meeting.
Services output growth in the third and fourth quarters was revised down slightly, resulting in a reduction in third-quarter GDP expansion from 0.6% to 0.5% with fourth-quarter growth unchanged at 0.7% rather than revised up (as earlier data had suggested).
The 2.8% annual rise in the GDP deflator in the fourth quarter was the strongest since 2008. The gross value added deflator – which excludes indirect taxes and subsidies – was up by 2.6%. Measured from the income side, employee compensation per unit of output rose by 2.3%, while the unit contribution of profits, rents and other income was up 3.1%. These numbers confirm that the current inflation pick-up has a significant domestic element.
The official measure of the household saving ratio fell to 5.2% in 2016 and 3.3% in the fourth quarter, a record low in data extending back to 1963. An alternative measure of the saving ratio derived from the financial / capital accounts remains significantly higher than the official series, giving a more favourable impression of consumer finances, but also declined last year – see first chart below and previous post for more details.
The current account deficit fell from 5.3% of GDP in the third quarter to 2.4% in the fourth, reflecting a smaller trade shortfall in goods and services and a further decline in the income deficit to the lowest since 2013 – second chart. The services trade surplus matched a previous record 5.4% of GDP last quarter as exports – particularly to non-EU countries – continued to grow robustly. The recent decline in the income deficit has been driven by a strong recovery in foreign direct investment earnings probably mainly due to the translation effect of sterling weakness and higher oil prices / profits – fourth-quarter earnings were up by 64% from a year earlier.
The combination of solid output expansion, accelerating domestic prices and a big decline in net income paid abroad resulted in gross national income surging by 7.4% in the year to the fourth quarter, the strongest annual increase since 2000 – third chart.