Eurozone monetary trends are sending an increasingly positive message for economic prospects. The narrow M1 and broad M3 aggregates posted further chunky monthly gains of 1.2% and 0.7% respectively in November. Six-month growth of real M1 and M3 (i.e. deflated by seasonally-adjusted consumer prices) rose to 4.7% and 2.5% (not annualised), the fastest since 2010 and 2009 – see first chart. This pick-up reflects faster nominal monetary expansion not falling prices – the CPI edged up by 0.1% in the six months to November.
The six-month real M1 change is an excellent leading indicator of the economy: it turned negative ahead of the 2008-09 and 2011-12 recessions, resuming growth before the intervening and subsequent recoveries. The current strong pace of expansion suggests upside risk to the consensus forecast of Eurozone GDP growth of 1.1% in 2015. Real M1 is now rising more rapidly than in the UK in early 2013, ahead of major positive growth surprise.
M1 has probably been boosted by interest rate declines and an associated rise in spending intentions, reflected in an increased transactions demand for money. M3 is more supply-driven: growth continues to be supported by a large balance of payments surplus*, while bank lending to government has picked up (partly in response to the TLTROs), outflows from longer-term savings instruments into deposits have increased and private sector credit contraction has slowed – adjusted for sales and securitisation, bank loans to non-government residents rose marginally in the latest three months.
The ECB publishes a country breakdown of overnight deposits, comprising about 80% of Eurozone M1. The pick-up in Eurozone six-month real deposit growth has been driven by the periphery (i.e. Italy, Spain, Greece, Ireland and Portugal) – second chart. Of the big four economies, growth remains strongest in Spain but is now significantly higher in France and Italy than Germany – third chart.
*Basic balance, i.e. current account plus net direct / portfolio investment flows.
UK GDP and services output figures released today suggest that the economy continues to grow robustly, contradicting widespread expectations of a second-half slowdown – see previous post. Downward revisions to earlier data, however, imply that productivity performance has been even weaker than thought, while indications of a rise in domestically-generated inflation have been confirmed.
The quarterly rise in GDP in the third quarter was left unrevised at 0.7% but “core” growth excluding the volatile oil and gas production sector was revised up to 0.8%. The economy started the fourth quarter solidly, with monthly output data covering services, industry and construction implying that GDP in October was 0.5% above its third-quarter level – see first chart. Quarterly growth, in other words, is on course to reach 0.7%-0.8% if GDP increases by 0.25% in November and December, in line with the year-to-date monthly average.
The main surprise in the GDP release was a significant downward revision to earlier growth estimates, resulting in a cut in the annual GDP increase in the third quarter from 3.0% to 2.6%. Aggregate hours worked in the economy rose by 2.2% in the year to the third quarter, so GDP per hour grew by only 0.4%. The MPC, by contrast, had expected an increase of 1.25%, according to this month’s minutes (see paragraph 23).
Continued productivity weakness has contributed to a rise in domestically-generated inflation. The deflator for “gross value added at basic prices” – a measure of prices of domestically-produced goods and services – increased by 2.4% in the year to the third quarter, revised up from 2.3%. Other GDP price measures cited by MPC member Kristin Forbes in an October speech as relevant for monitoring domestic inflation are rising more strongly – second chart.
The MPC’s dovish majority has counted on a slow recovery in pay growth being partially offset by a recovery in productivity expansion. The earnings pick-up, however, appears to be occurring sooner than expected – see previous post – while tentative signs of a productivity revival have been revised away. The MPC’s leading dove, Mark Carney, is likely to shift focus to other reasons for keeping interest rates on hold, such as the supposed risk of current artificially-low headline consumer price inflation “destabilising” inflationary expectations.
In further disappointing news, the current account deficit widened to a new cash record in the third quarter, with the ratio to GDP equalling the series high of 6.0% reached in the third quarter of 2013. The rise was driven by a further widening of the investment income deficit; the goods and services shortfall, by contrast, remains moderate and stable – third chart.
Paul Krugman recently drew a parallel between the Federal Reserve’s plans to raise interest rates in 2015 and the ECB’s ill-fated 2011 policy tightening, which was swiftly followed by a recession. The monetary context is different, however, casting serious doubt on the comparison.
Former ECB President Jean-Claude Trichet bears the unfortunate distinction of having raised rates on two separate occasions in the teeth of an oncoming recession – August 2008 and April / July 2011 (a double increase). These decisions were astonishing from a monetarist perspective because they were taken against the backdrop of a contracting real (i.e. inflation-adjusted) money supply, as measured by the narrow M1 aggregate – see chart. The associated recessions, in other words, would have occurred anyway but were certainly magnified by the ECB’s actions.
US real M1 growth has fallen back since mid-2014 but remains at a respectable level. A pick-up around end-2013 signalled economic strength in mid-2014 – GDP is currently estimated to have grown at a 4.2% annualised rate in the second and third quarters, although this partly reflects payback for a weak start to the year. The recent real M1 slowdown may herald a moderation in GDP expansion to a 2-3% pace. Monetary trends would need to weaken significantly further to suggest economic danger from a small interest rate rise.
Professor Krugman’s worries, therefore, are premature. The ECB, meanwhile, may be repeating its 2008 / 2011 mistakes in reverse, with President Draghi and his allies seemingly determined to push through sovereign QE in early 2015 despite recent strong monetary growth and building evidence of an economic upswing.
Today’s UK labour market statistics cast doubt on the MPC majority forecast of a slow recovery in pay growth accompanied by improved productivity performance. Private sector regular earnings rose by 2.3% in the year to October, the largest annual gain since March 2012. Earnings in the latest three months grew by 4.2% annualised from the previous three.
Aggregate hours worked, meanwhile, rose by 0.7% in the three months to October from the previous three, suggesting that a slowdown during the summer was noise rather than indicative of a step-up in underlying productivity growth.
Earnings acceleration is consistent with historical evidence of a lagged relationship with job openings (vacancies), discussed in a post in September. The job openings rate (i.e. vacancies as a percentage of filled and unfilled jobs) rose further in the three months to November, moving closer to its 2008 peak – see chart.
The current commodities-driven plunge in headline CPI inflation is obscuring a pick-up in domestic cost pressures, evidenced by a faster rise in the gross value added (GVA) deflator as well as higher pay growth. Today’s MPC minutes made no mention of the increase in annual GVA inflation to 2.3% in the third quarter, a two-year high – see previous post. Complacent policy-makers may be sowing the seeds of another inflation overshoot.
Eurozone business surveys are starting to confirm the improved economic outlook signalled by monetary trends and leading indicators – see previous post.
The Eurozone manufacturing purchasing managers’ new orders index rose back above the breakeven 50 level in December after three months below it. This turnaround has occurred on schedule following a recovery in the longer leading indicator calculated here from a low in May – see first chart.
The December ZEW survey, meanwhile, reported a further solid gain in German economic expectations, which should be mirrored directionally by the more widely-watched Ifo survey released on Thursday – second chart.
These improvements are unlikely to deflect ECB President Draghi from attempting to drive through sovereign QE in early 2015. His hand has been strengthened by modest take-up of last week’s TLTRO2 lending operation. As the table shows, the TLTRO2 loan was less than half that required to offset the repayment of earlier three-year LTRO loans by end-February 2015. With private sector asset purchases unlikely to fill the gap, the balance sheet may contract slightly in early 2015, casting further doubt on the achievability of the ECB’s “intended” expansion of about €1 trillion on a reasonable time scale without sovereign QE.
|Longer-term refinancing operations|
|Repayment of three-year LTROs from 2011-12 by Feb-15||-271|
|Implied net change by Feb-15||-141|
|Covered bond / ABS purchases|
|Addition by Feb-15 assuming €5 billion per week||60|
|Combined impact by Feb-15||-81|