Strong October auto sales support the assessment here that the global economy is reaccelerating. Aggregate sales, seasonally adjusted, in the G7 and seven large emerging economies (the “E7”) rose to a record last month, reflecting another bumper outturn in the US and a sharp increase in China, following a cut in the sales tax on smaller-engined vehicles from 10% to 5% – see first chart.
Auto sales are a short leading indicator of the economic cycle. The increase since mid-year has coincided with a pick-up in retail sales growth and suggests that a recent recovery in industrial output momentum will extend into end-2015, at least – second chart. Global real narrow money trends, meanwhile, are giving a reassuring message for economic prospects in the first half of 2016 – see previous post.
China bears were energised by October trade numbers, showing a 6.9% annual decline in exports in US dollars, following a 3.7% September fall. Adjusting for the seasonal pattern, however, October exports were little changed from September and 6.9% above the first-half average. Chinese exporters continue to outperform their competitors; German September numbers, for example, show a 9.2% dollar-terms drop from a year before – third chart.
A near-record trade surplus coupled with reduced capital outflows, meanwhile, resulted in a small rise in Chinese foreign exchange reserves last month, following a large fall during the third quarter. The PBOC has been cutting banks’ reserve requirement ratios to offset a liquidity drain from intervention; with currency flows back in balance, the prospect of further reductions is receding.
The November Inflation Report is notably more dovish than its August predecessor, mainly reflecting increased MPC concern about slowing emerging economies. The change in tone probably also reflects a desire to minimise upward pressure on sterling should the ECB ease policy further in December.
The change in the MPC’s collective opinion is summarised by the two-year-ahead mean inflation forecast based on unchanged policy, which has been cut from 2.6% in August to 2.3% in November, returning it to its level in May. The implication is that a rate rise is no more urgent now than it was in May.
The 2.6% August forecast chimed with Governor Carney’s July statement that a decision to raise rates would “come into sharper relief around the turn of this year”, i.e. five months later. The November cut in the forecast suggests that a rise is still at least five months away, i.e. next spring at the earliest.
The view here, based on monetary trends, is that global and domestic economic prospects are stronger than the MPC judges. If correct, incoming news should shift the Committee in a hawkish direction by the time of the February Inflation Report.
An additional significant announcement today was new “guidance” that the MPC expects to maintain the stock of asset purchases at £375 billion until Bank rate returns to around 2%. This increases the risk of an abrupt rise in rates since the alternative policy tightening option of early asset sales is no longer available.
It is widely recognised that current low global consumer price inflation reflects a temporary drag from weak commodity prices. Much commentary, however, asserts that “core” inflation is also unusually subdued. Not so.
The first chart below shows headline and core inflation aggregates for the G7 countries and seven large emerging economies (the “E7”). The core definition varies slightly across countries but in most cases excludes all food and energy items*. The country data were aggregated using GDP weights.
G7 plus E7 headline CPI inflation was 1.7% in September, equal to a low reached in January and the least since October 2009. Core inflation, by contrast, rose to 2.7%, the highest since September 2008.
The elevated core rate mainly reflects E7 strength – second chart. The E7 aggregate has been driven up by surges in core inflation in Russia and Brazil, caused by currency collapses – current core rates are 9.1% and 16.6% respectively. In addition, however, G7 core inflation has been drifting higher and is slightly above its average over the past 10 years – 1.5% versus 1.4%.
Lower commodity input costs and cheaper manufactured imports from weak-currency emerging economies have been pulling down on the G7 core rate, so the observed rise indicates a pick-up in domestic inflationary pressures. G7 labour markets are now relatively tight, with the unemployment rate down by a further 0.6 percentage points to 5.8% over the past 12 months – equal to its level in mid-2006 when G7 core inflation was also rising.
With monetary trends suggesting improving global and E7 economic prospects, commodity prices and E7 currencies may stabilise or recover. If so, G7 core inflation is likely to continue to move higher, while the E7 core rate should moderate as imported price rises slow.
*Japan: additionally excludes impact of 2014 sales tax rise. Brazil: includes some food items. India: includes vehicle fuel, excludes additional items. Russia: includes some food items, excludes additional items.
The US economy performed robustly over the spring and summer. GDP growth, admittedly, fell from 3.9% at an annualised rate in the second quarter to 1.5% in the third, according to preliminary data. This slowdown, however, largely reflected a decline in stockbuilding: final sales rose by an annualised 3.0% last quarter. GDP growth averaged a solid 2.7% across the two quarters.
Economic health in mid-2015 had been signalled by narrow money trends at end-2014. Six-month growth of real narrow money fell sharply in summer 2014, warning of a loss of momentum in early 2015, allowing for the usual lag. It rebounded strongly from October, however, peaking in February 2015 – see first chart. The message was that the poor start to the year – exacerbated by bad weather – represented a temporary soft patch, with news likely to improve significantly later in 2015.
The consensus expects growth to remain strong by the standards of the upswing to date. The mean forecast for annual GDP expansion in 2016 is 2.6%, according to Consensus Economics, with the IMF projecting 2.8%. This compares with average growth of only 2.1% annualised from the recession trough in the second quarter of 2009 through the third quarter of 2015.
This optimism is questionable, for two reasons. First, real narrow money has slowed again since the spring, with six-month growth in August / September the lowest since January 2010, and weekly data suggesting no recovery in October. Real M2 and bank lending are holding up better but have also lost momentum – first chart.
Secondly, stock changes are likely to be a further drag on GDP growth over coming quarters. The 3-5 year Kitchin stockbuilding cycle last bottomed in 2012, so another trough is due in 2016 or 2017. As previously discussed, the ratio of non-farm inventories to final sales of goods and structures is usually above its long-run downward trend at the peak of the cycle, and below it at the trough. It remained elevated at end-September, despite the fall in stockbuilding last quarter – second chart.
Strengthening non-US real narrow money growth – particularly in China – suggests that the global economy can regain momentum even if the US slows. Economic “rebalancing” from the US to the rest of the world would be favourable for markets, supporting equity earnings while allowing the Fed to go slow on rate rises. The current monetary evidence supports this benign scenario but further US narrow money weakness, or a relapse in China or the Eurozone, would warrant a reassessment.
Annual growth of broad liquidity held by UK households and private non-financial corporations (PNFCs) rose from 6.1% in August to 6.2% in September, the fastest since June 2008. Corporate money, in particular, is surging, suggesting strong prospects for business spending. If the recent stability of the velocity of broad liquidity were to persist, sustained growth at the current pace would cause inflation to overshoot the 2% target over the medium term.
The strengthening of liquidity trends is underappreciated because most commentary focuses on the Bank of England’s M4ex* broad money aggregate, annual growth of which has remained at about 4% (3.9% in September) – see first chart. The increase in M4ex over the past 12 months, however, was depressed by 1) older savers switching out of bank deposits into National Savings (NS) pensioner bonds and 2) a fall in financial sector money. Neither development is of economic significance**.
A better guide to the availability of liquidity to finance private sector spending at present is the sum of M4 money held by households and PNFCs – i.e. “non-financial M4” – and outstanding NS. Of the 2.3 percentage point gap between the annual growth rates of this aggregate (6.2%) and M4ex (3.9%), about two-thirds is due to the NS effect and one-third to falling financial sector deposits.
The velocity of circulation of this liquidity measure has been broadly stable in recent years – see previous post. If velocity were to continue to move sideways, sustained 6% liquidity growth would be reflected, in time, in an equal rate of increase of national income. This, in turn, would imply inflation of about 3.5%, assuming 2.5% trend output expansion.
Annual growth of both corporate and household liquidity has risen over the past year but the former is much stronger – 12.4% versus 4.8%. Significant changes in corporate liquidity growth have foreshadowed economic fluctuations in recent years. Corporate liquidity contracted before the 2008-09 recession and the 2011-12 “double-dip” scare, but rebounded sharply in 2012 ahead of the positive GDP growth surprise in 2013 – second chart. The further increase in liquidity expansion this year casts doubt on the consensus forecast of slower GDP growth in 2016 than 2015.
The suggestion that monetary conditions have loosened, requiring an early policy response, is supported by still-robust expansion of narrow money, as measured by non-financial M1, and a continued pick-up in bank lending to households and PNFCs, annual growth of which reached 2.2% last month, the fastest since April 2009 – third chart. Leading indicators suggest further credit acceleration: mortgage approvals reached another post-recession high in value terms last month, while annual growth of arranged but undrawn credit facilities rose to 6.0%, the fastest since December 2004.
*M4ex = M4 excluding holdings of “intermediate other financial corporations”.
**The £11 billion fall in financial sector M4 in the year to September may partly reflect a switch from bank deposits to other liquid instruments: private-sector holdings of Treasury bills and other central government debt (mainly short-term repo borrowing by the Debt Management Office) rose by £8 billion over the same period.