UK data wrap: more grist for MPC hawks

Posted on Tuesday, October 10, 2017 at 12:43PM by Registered CommenterSimon Ward | CommentsPost a Comment

Recent UK data releases have further boosted the probability of a November rate hike while suggesting that the accompanying Inflation Report will signal a need for additional policy tightening.

Whole-economy unit labour costs (ULC) rose by 2.4% in the year to the second quarter of 2017, far above a Bank of England staff estimate of 1.0% in the August Inflation Report. The MPC then expected ULC growth of below 2% in both 2017 and 2018, justifying its forecast of a slow return of inflation to the 2% target as import price pressures faded. A major reassessment is now required.

The overshoot in ULC growth relative to the Bank staff estimate reflects a stronger-than-expected rise in non-wage labour costs and weaker-than-expected productivity performance. Non-wage costs (i.e. “employers’ social contributions”) per employee rose by 7.1% in the year to the second quarter, apparently driven by pensions. Whole-economy output per hour, meanwhile, fell by 0.3% in the year to the second quarter versus an MPC “key judgement” of growth of just under 0.5%.

ULC growth of 2.4% in the second quarter was down from an upwardly-revised 3.5% in the first quarter. The latter number incorporated a rise in employers’ national insurance contributions from April 2016 associated with the introduction of the single-tier state pension. This increase dropped out of the year-on-year comparison in the second quarter.

Second-quarter ULC growth of 2.4% is arguably understated because it does not take account of the apprenticeship levy introduced in April. The levy is forecast by the OBR to raise £2.7 billion in 2017-18, equivalent to 0.25% of total employee compensation.

A November rate hike could, in theory, be derailed by a weak preliminary estimate of third-quarter GDP growth to be released on 25 October. August activity data released today, however, suggest that GDP will be reported to have risen by 0.3-0.4% from the second quarter, i.e. no lower than the Bank staff estimate of 0.3% at the time of the September MPC meeting.

The key release was services turnover, which receives little attention but is an input to services output, an August number for which will be reported at the same time as third-quarter GDP. August turnover along with previously-released retail sales suggest that services output more than reversed a 0.2% July fall. Incorporating industrial and construction output for August also released today, the level of GDP in August may have been 0.3-0.4% above the second-quarter level.

The ONS will have limited information about September activity when it releases the third-quarter GDP estimate, so will rely partly on statistical extrapolation. Assuming a further 0.1% monthly GDP rise in September, implied third-quarter growth would be 0.3-0.4%.

A "monetarist" perspective on current equity markets

Posted on Friday, October 6, 2017 at 09:41AM by Registered CommenterSimon Ward | CommentsPost a Comment

Global monetary trends are signalling solid economic growth through early 2018, at least. This prospect suggests a further tightening of labour markets, which may cause central banks to accelerate plans for policy normalisation, even if inflation remains quiescent. US Treasury borrowing ahead of the reimposition of the federal debt ceiling in December, meanwhile, may have a temporary negative impact on US monetary conditions. A cautious investment stance, therefore, may be warranted, despite favourable economic trends.

Previous commentaries suggested that the global economy would lose momentum over the summer and autumn before reaccelerating in late 2017 / early 2018. This forecast is on track but the growth pull-back to date has been modest. Six-month growth of industrial output in the G7 developed economies and seven large emerging economies (the “E7”) peaked in April 2017 but remained solid through August – see first chart. The equity analysts’ earnings revisions ratio has fallen back but business surveys have stayed strong – second chart.

The basis for the forecast that economic expansion would moderate from spring 2017 was a fall in G7 plus E7 real narrow money growth between August 2016 and February 2017  – monetary trends lead the economy by about nine months on average*. Real money growth, however, recovered solidly between February and June, suggesting a restrengthening of economic momentum around end-2017. June may have marked another peak in real money growth but July / August data remained positive – first chart.

The message from monetary trends is supported by a global (i.e. G7 plus E7) leading indicator derived from the OECD’s country leading indicators, which combine a wide range of economic and financial series (but generally exclude money). The global measure, which typically leads activity by four to five months, slowed in late 2016 / early 2017 but has regained momentum over the summer, consistent with the forecast of near-term economic strength – third chart.

US real narrow money growth has rebounded strongly from weakness in early 2017, suggesting robust GDP expansion in late 2017 / early 2018 – fourth chart. The unemployment rate has stabilised at 4.3-4.4% since the spring but could fall further to 4% or below. Core inflation has declined unexpectedly but this partly reflects temporary influences, such as a large fall in mobile data charges. Fed officials are aware of a possible parallel with the 1960s, when core inflation rose sharply as the jobless rate moved through 4% – fifth chart. Policy rates may rise faster than markets currently discount, boosting the US dollar.

Chinese real narrow money growth fell in late 2016 / early 2017 but has stabilised since the spring at a level consistent with respectable economic expansion – sixth chart. Policymakers have clamped down on housing speculation, shadow financing and polluting activities but plan to support growth via infrastructure spending and targeted easing, such as a recent cut in reserve requirements for small business lending. Current monetary trends suggest that they are on track.

US real narrow money growth is now at the top of the range across major developed economies, along with Canada – seventh chart. UK expansion, meanwhile, has recovered modestly, while growth in Japan and Euroland has moderated. These trends suggest improved relative economic prospects for the US and UK and may warrant adding to equity market exposure, partly on the expectation of better currency performance.

The outperformance of emerging market equities since early 2016 was signalled by E7 real money growth crossing above the G7 level in late 2015 and remaining higher through early 2017 – eighth chart. This positive signal has now reversed, suggesting reducing EM exposure.

Globally, liquidity conditions still appear supportive for markets. Research reported previously found that major equity market declines historically were preceded by one or more of the following conditions: G7 annual real narrow money growth falling below 3%; real money growth falling below industrial output growth; and real money growth falling by 3 percentage points or more within six months. The performance relative to US dollar cash of two switching rules based on these conditions is shown in the ninth chart. The rules would have captured a significant portion of relative equity gains while limiting losses during bear markets.

The three conditions are not yet close to being triggered. G7 annual real narrow money growth of 6.3% in August, however, was down from an October 2016 peak of 8.7%, while the real money / industrial output growth gap has narrowed significantly – tenth chart. Liquidity conditions, therefore, are probably the least favourable since mid-2014 – equity markets made no progress over the subsequent two years.

A near-term concern is that the US Treasury will “overfund” the federal deficit before the debt ceiling is reimposed in December in order to replenish its cash balance at the Fed. An earlier run-down of this balance boosted the monetary base and may have contributed to the pick up in real narrow money growth since early 2017 noted earlier – final chart. A reversal of this effect could have a temporary disruptive impact on markets, particularly if accompanied by strong economic data and an associated upward revision to interest rate expectations.

*Narrow money = currency in circulation plus demand deposits and close substitutes. Broad money = narrow money plus time deposits, notice accounts, repos and bank securities. Precise definitions vary by country. Narrow money has been more reliable than broad money for forecasting purposes historically and is consequently emphasised in the analysis here. Real = inflation-adjusted. The G7 plus E7 narrow money series shown, and an E7-only series in a later chart, incorporate an adjustment to reduce a distortion from India’s demonetisation programme.

UK money trends improving

Posted on Friday, September 29, 2017 at 01:09PM by Registered CommenterSimon Ward | CommentsPost a Comment

UK money trends have firmed since early 2017, suggesting that GDP growth will recover from its soft first-half pace.

Non-financial M1 – which, as in Euroland, outperforms other monetary aggregates as a leading indicator of the economy – rose by a solid 0.7% in August following a 0.4% July gain. Six-month growth bottomed in March and moved up to 3.7% or 7.5% annualised in August, very close to the Euroland pace – see first chart and previous post.

The broader non-financial M4 measure rose by 0.6% in August after 0.1% in July, while its six-month growth increased to 2.4% or 4.8% annualised – the fastest since December 2016.

The turnaround in six-month real (i.e. inflation-adjusted) money growth has been more pronounced because the six-month rate of increase of consumer prices (seasonally adjusted), while still elevated, has moderated from a peak in April – first and second charts. Real money growth, however, is lower than over 2014-16, suggesting that GDP expansion will remain subdued by recent standards.

The sectoral split of non-financial M1 supports a modestly positive interpretation, with growth of real money holdings of both households and private non-financial corporations (PNFCs) firming recently. Corporate growth is at a respectable level by historical standards, consistent with businesses maintaining expansion plans despite Brexit uncertainty.

The Office for National Statistics today released national accounts revisions through the second quarter of 2017 as well as July services output. GDP growth in the second quarter was unchanged at 0.3% but first-quarter expansion was revised up from 0.2% to 0.3%. Growth estimates for the third and fourth quarters of 2016, however, were lowered, i.e. the slowdown between the second half of 2016 and first half of 2017 was less pronounced than previously reported.

Services output fell by 0.2% in July from June. Incorporating previously-released data on industrial and construction output, July GDP was only 0.1% above the second-quarter level. July services weakness, however, was mostly accounted for by a fall in motion pictures output, which is volatile and now below its recent trend. Assuming a rebound in such output, GDP is probably still on course to meet the Bank of England staff's projection of 0.3% growth in the third quarter.

Euroland August money numbers better but trends cooling

Posted on Wednesday, September 27, 2017 at 12:24PM by Registered CommenterSimon Ward | CommentsPost a Comment

Euroland money measures rebounded from July weakness in August. Six-month growth, however, has fallen since early 2017, suggesting that GDP expansion will moderate in late 2017 / early 2018.

Non-financial M1 – the monetary measure with the strongest historical forecasting record, according to ECB research – rose by 1.0% in August, following no change in July. The broader non-financial M3 measure was up by 0.6%, having fallen 0.1% in July*.

Six-month growth of non-financial M1 moved back up to 3.8% (7.7% annualised) – solid by historical standards but well down from a March peak of 5.6% (11.5% annualised). Non-financial M3 growth has also cooled since then. Bank lending expansion has been stable but is a coincident / lagging indicator of the economy (confirmed by the ECB research) – see first chart.

The monetary slowdown has been mild in real (inflation-adjusted) terms because of a simultaneous decline in the rate of increase of consumer prices (seasonally adjusted) over the spring and summer. Real  money growth, however, has pulled back sufficiently to suggest a slowing of economic momentum in late 2017 / early 2018 – second chart. Six-month inflation, moreover, is likely to rebound, so real money trends may weaken further.

Robust GDP growth of 1.2% or 2.4% annualised during the first half of 2017 partly reflected strong net exports, which may face headwinds from a 7.2% rise in the euro effective exchange rate between December and August. Domestic demand rose by 0.6% or 1.3% annualised in the first half – third chart.

Real narrow money trends were much stronger in Euroland than the US in late 2016, suggesting superior economic prospects. GDP expanded by an annualised 2.4% in Euroland between the third quarter of 2016 and second quarter of 2017 versus 2.0% in the US. With US real non-financial M1 growth now back above the Euroland level, the US economy is likely to outperform in late 2017 / early 2018.

*Non-financial = held by households and non-financial corporations.

US Q2 flow of funds: more reasons for economic optimism

Posted on Friday, September 22, 2017 at 11:51AM by Registered CommenterSimon Ward | CommentsPost a Comment

The positive view here of US economic prospects for late 2017 / early 2018 is supported by additional monetary data in the Fed’s second-quarter financial (flow of funds) accounts released yesterday.

Previous posts have highlighted a strong pick-up in six-month growth of real narrow money, as measured by M1A divided by consumer prices, since early 2017*. The preferred narrow money measure here, however, is non-financial M1, i.e. covering holdings of households and non-financial businesses but excluding the financial sector. This can be derived from the financial accounts but the numbers are quarterly and lag the monthly M1 / M1A data by two months.

Figures through end-June show that real non-financial M1 has accelerated even more strongly than real M1A. Six-month growth, indeed, was the highest since early 2014, ahead of two quarters of 4% plus annualised GDP expansion – see first chart.

Broad money trends, meanwhile, remain stable and solid. The Fed stopped publishing M3 in 2006 but a close substitute can be reconstructed from the financial accounts. Total and non-financial M3 grew by 6.1% in the year to June – second chart.

The financial accounts also include data on sectoral net lending, i.e. saving minus investment. The household and domestic business sectors ran stable surpluses in the second quarter, of 1.5% and 0.6% of GDP respectively – third chart. The business surplus suggests favourable prospects for investment and hiring – no recession since 1950 (at least) began with the business sector in surplus.

The combined household / business surpluses reflect a general government deficit of 4.7% of GDP – worryingly large for an economy at or near full employment. There is, of course, little prospect of this being cut back any time soon and a significant risk of further widening if the Trump administration and Congressional Republican majorities coalesce around unfunded tax cuts.

*M1A = currency in circulation plus demand deposits. M1 also includes other checkable deposits. The two measures have behaved similarly in recent years. M1A is preferred for the historical reason that M1 was heavily distorted by sweep account programmes in the 1990s.