OECD leading indicators released next week should confirm that global economic growth is moderating, in line with the forecast here. Monetary trends, however, suggest that the slowdown will be modest and temporary, with growth lifting again from the summer.
The first chart shows the OECD’s “normalised” G7 leading indicator, constructed so that a stable value implies economic expansion at trend. A peak in the indicator, in other words, signals that growth is about to shift from above to below trend. The chart shows actual data up to December 2013 together with a series estimated here by attempting to replicate the OECD’s calculations using the latest component information. The estimation suggests that values for November and December will be revised lower, while the indicator will fall marginally in January. The new OECD data, in other words, may strengthen market perceptions of a slowdown in growth in early 2014.
The second chart shows global (i.e. G7 plus emerging E7) industrial output growth together with short and longer-term leading indicators constructed here by combining and transforming the OECD’s normalised indicators for the G7 and individual emerging economies. These short and longer-term measures have led growth turning points by averages of 2-3 months and 4-5 months respectively in recent years. The latest values are again estimated; the short leading indicator is likely to fall further in January while the longer measure may stabilise at a weak level.
The bias here, however, is to downplay the cautionary message from the leading indicators, for two reasons. First, recent weakness may have been exaggerated by the impact of bad weather on several of the components (e.g. US housing starts). As this effect unwinds, the trend estimates of the components incorporated in the indicators should be revised higher. The recent declines, in other words, may look smaller in three months’ time.
Secondly, the leading indicators are used here to confirm signals from global real narrow money expansion, which has led output growth turning points by an average 6-7 months in recent years. Real money expansion declined between May and September 2013, anticipating current economic softening – third chart. It bottomed at a respectable level, however, and has picked up in December / January, with US strength likely to result in a further rise in February – see previous post. Monetary trends, in other words, suggest that the slowdown will be modest and growth will regain momentum, led by the US, from mid-2014. Such a scenario, in turn, implies that the longer leading indicator should be at or close to a bottom.
A simplistic growth forecasting rule based on the money supply and share prices – a rule that correctly predicted that the economy would beat expectations in 2013 – suggests that 2014 will be another strong year; GDP is projected here to rise by about 3%.
The forecasting rule assesses growth prospects for the coming calendar year based on whether December levels of real (i.e. inflation-adjusted) money supply growth and share prices are higher or lower than 12 months earlier. Real money growth is measured by the annual rate of change of the narrow M1 aggregate deflated by the retail prices index (RPI). Share prices are measured by the domestically-orientated FT30 index, again deflated by the RPI.
Annual GDP growth averaged 2.5% in the 47 calendar years from 1966 to 2012. The forecasting rule gave a “double-positive” signal in 23 of these years (i.e. both real money growth and share prices at the end of the prior year were higher than 12 months before). GDP growth in these years averaged 3.8%.
There were, by contrast, 15 years when the forecasting rule gave a “double-negative” signal. Growth in these years averaged just 0.4%. In the remaining 9 cases where the money supply and share prices gave conflicting signals GDP expansion averaged 2.5%*.
As noted, the forecasting rule predicted that the economy would perform well in 2013 – the December 2012 real level of the FT30 index was up by 16.8% from a year earlier, while the annual change in real M1 was 3.6% versus -4.9% in December 2011. GDP is currently estimated to have risen by 1.8% in 2013 but the increase was 2.7% measured from fourth quarter to fourth quarter. Upward revisions are likely.
The rule also outperformed the consensus in 2012: a double-negative signal was given at the end of 2011, ahead of growth of only 0.3% in 2012 and associated double / triple dip scares. A prior double-negative was issued at end-2008; GDP slumped by 5.2% in 2009.
Both conditions are still positive for 2014. The FT30 index in December 2013 was 24.7% higher than a year before, implying a real gain of 21.5% allowing for December RPI inflation of 2.7%. Annual real M1 growth, meanwhile, was 7.4% versus 3.6% at end-2012**.
The forecast here of GDP growth of about 3% in 2014 is beneath the 3.8% average for double-positive years. This partly reflects a judgement that weak productivity performance has lowered potential output growth to below 2% per annum currently versus a long-run average of about 2.5%.
*Using a broad rather than narrow money measure produces similar results. For example, a rule based on non-financial M4 (i.e. M4 held by households and private non-financial corporations) yields average GDP growth in double-positive years of 3.9% (16 years) and in double-negative years of 0.7% (11 years).
**Broad money signals differ according to the aggregate used. Real growth of M4 and non-financial M4 was higher in December 2013 than December 2012 but that of M4ex (i.e. M4 excluding holdings of financial intermediaries) was lower (1.0% versus 1.9%). GDP growth has averaged 2.6% in previous years with positive stock market and negative M4ex signals.
UK money measures that correctly predicted recent economic strength suggest stable, solid GDP expansion through summer 2014 at least.
Real non-financial M1 – currency and sterling sight deposits held by households and private non-financial firms, deflated by consumer prices – rose by 4.5% (not annualised) in the six months to January. Growth has been stable since spring 2013 and is well above the long-run average – see first chart.
Real non-financial M4, including time deposits and savings accounts, rose by a smaller 1.4% in the latest six months. Its growth has also been stable since last spring but is beneath the long-run average. This shortfall is not a constraint on economic expansion because the velocity of circulation is now on a rising trend*, partly reflecting the impact of negative real interest rates on the demand to hold broad money.
The six-month rates of change of the two real money measures bottomed in April 2011, rising over the subsequent two years to peak in April 2013. Underlying two-quarter GDP expansion (i.e. excluding North Sea production and adjusting for special bank holidays and the Olympics) bottomed in the first quarter of 2012 and rose through the third quarter of 2013, stabilising in the fourth quarter. This is consistent with the monetarist rule that (real) money supply changes lead demand and output by about six months.
Stable real money trends since last spring suggest that GDP will continue to grow by about 0.75% per quarter through the third quarter of 2014.
The consensus focuses on credit trends, neglecting that credit lags the economy whereas the money supply leads. The six-month rate of change of real non-financial M4 lending was consistently negative between June 2009 and November 2013, helping to explain consensus bearishness on the economy – second chart. It has recently turned marginally positive but this development contains no information about economic prospects.
*The ratio of current-price GDP to non-financial M4 rose by 1.0% per annum (pa) between the second quarter of 2009 and the fourth quarter of 2013 versus a fall of 2.4% pa between 1994 and 2009.
Eurozone real non-financial M1* – the best monetary leading indicator of the economy, with a flawless track record in recent years – continues to signal improving prospects. Real money expansion is now stronger in peripheral economies than the core.
Six-month growth of real non-financial M1 rose to 3.7% (not annualised) in January, equalling November’s result, which was the strongest since February 2010. The six-month change turned negative before the 2008 and 2011 recessions and positive before the 2009 and 2013 recoveries – see first chart. The recent pick-up suggests that industrial output and GDP growth will firm through the late summer (at least).
The ECB publishes country data on overnight deposits, which dominate swings in M1. Six-month growth of real deposits in the peripheral grouping** rose to 3.8% in January versus 2.2% for the core – second chart. Peripheral expansion was lower than in the core in every month between September 2008 and October 2013.
The groupings conceal significant country variation, with Spain now the strongest of the big five, followed by Germany / Italy. French growth is modest but still consistent with an ongoing economic recovery; negative risks are greater in the Netherlands – third chart.
*Notes and coin in circulation plus overnight deposits of households and non-financial corporations divided by consumer prices, seasonally adjusted.
**Greece, Ireland, Italy, Portugal and Spain.
The official estimate of fourth-quarter GDP growth has been maintained at 0.7%, although revisions to earlier quarters have resulted in the annual increase falling from 2.8% to 2.7%. As expected here, services output undershot the 0.4% December rise assumed in the preliminary GDP estimate (increasing by 0.2%); the impact on the quarterly GDP rise, however, was offset by upward revisions to earlier months.
The key takeaway from the details of today’s report is that recent solid growth has been broadly based and balanced, increasing confidence in its sustainability. Consumer spending rose by less than GDP in the year to the fourth quarter – 2.4% versus 2.7%. Investment, meanwhile, soared by 8.7%; business fixed capital formation grew by 8.5%, with a stronger rise in housing investment*. Net exports were little changed over the four quarters – import penetration**, encouragingly, fell. The only negative in the expenditure breakdown was relatively high stockbuilding during the second half of 2013; the stockbuilding numbers, however, incorporate a balancing adjustment and are often revised significantly.
Solid growth is occurring across sectors and most activities: output of services, industry and construction rose by 2.7%, 2.3% and 4.3% respectively in the year to the fourth quarter. Services strength does not reflect finance – output of “financial and insurance activities” actually fell by 1.8% in the latest four quarters, subtracting 0.2 percentage points from GDP growth.
The income breakdown shows a 3.9% nominal rise in total employee compensation – including employers’ social (pension) contributions – in the year to the fourth quarter. The number of employees increased by 1.1% over the same period, according to last week’s labour force survey. So average compensation grew by 2.8% – more than CPI inflation of 2.1% in the fourth quarter***.
Adding in profits and other income, nominal GDP rose by an annual 4.4% in the fourth quarter. With potential output probably growing by less than 2% per annum, this rate of increase is incompatible with achievement of the 2% inflation target over the medium term.
*The difference between total and business investment suggests that the housing component grew by about 12%.
**The import share of domestic demand.
***A fourth-quarter breakdown between wages / salaries and employers’ social contributions is not yet available.