Bank of England gilt purchases have contributed to a pick-up in UK broad money growth. In the US, however, M2 expansion has slowed since early 2009, despite ongoing large-scale bond-buying by the Federal Reserve – see first chart. What explains this divergence?

Central bank lending or asset buying has a direct positive impact on the broad money supply only when transactions are conducted with domestic non-banks. One possible explanation for the UK / US monetary divergence is that the Bank of England has been buying securities from non-banks while the Fed has been buying from banks.

Available evidence, however, does not support this interpretation. For example, US flow of funds accounts for the first quarter show that Fed purchases of agency and mortgage-backed securities were more than accounted for by sales by the household sector (which includes domestic hedge funds). Commercial banks' holdings of such securities were little changed last quarter.

Rather than ineffective bond purchases, the US M2 slowdown appears to reflect two other factors absent in the UK. First, commercial bank credit has contracted by 3% (not annualised) since December 2008. By contrast, UK M4 lending rose by about 2% between December and May (based on the Bank of England's adjusted measure excluding transactions with financial intermediaries).

Secondly, the monetary impact of the Fed's bond-buying has been offset by a contraction of its liquidity swap lending to other central banks. Swaps ballooned in late 2008 as policy-makers sought to alleviate an international shortage of dollars. Some of the cash is likely to have flowed back to the US, contributing to faster M2 growth late last year. This process has reversed in 2009: liquidity swap lending has contracted by $405 billion since the start of the year – almost as large as the Fed's $487 billion combined purchases of Treasuries, agencies, mortgage-backed securities and commercial paper.

As well as contributing to the slowdown in broad money M2, the fall in swap lending has neutralised the impact of the Fed's bond purchases on the monetary base M0 (i.e. currency plus bank reserves), which has been static since the start of the year. In the UK, however, M0 has surged since the Bank of England embarked on QE, with annual growth recently overtaking the US – second chart.

Slower M2 growth, should it persist, is a threat to US economic prospects but there are grounds for expecting an improvement. Recent credit weakness partly reflects heavy destocking, which is now coming to an end. Similarly, the contraction in the Fed's swap lending is probably largely complete – the amount outstanding is down to $149 billion from a December peak of $583 billion. As these drags abate, monetary trends should be dominated by the positive impact of ongoing Fed securities purchases.