UK monetary trends continue to suggest a recovery in economic momentum during the course of 2012, though to an uncertain extent.
Recent economic weakness was signalled by a contraction in real broad and narrow money in late 2010 and early 2011 – see first chart. The preferred broad measure here is non-financial M4, comprising holdings of households and non-financial companies. Its six-month real change reached a low of -2.7% (not annualised) in April 2011 but was recovering before the MPC launched QE in October. Today’s March release shows a further rise to 0.8% – the strongest since early 2009, just ahead of a spurt in growth.
The hopeful message from broad money, however, is clouded by continued weakness in real narrow money M1, although its decline has slowed since early 2011. M1 may have been depressed by banks’ bidding more aggressively for term funding – the spread between the average rates on household time and interest-bearing sight deposits has widened from 1.67% to 1.83% over the last year. The non-interest-bearing component of M1, moreover, is growing solidly. These considerations suggest placing more weight on the broad money signal at present.
A further positive development is a recovery in the corporate liquidity ratio (i.e. sterling plus foreign currency deposits of non-financial companies divided by their bank borrowing) in the first quarter, reversing a decline during the second half of 2011 – second chart.
Note that the traditional M4 broad money measure is currently being distorted by a contraction of interbank financial activity channeled through “intermediate other financial corporations” – such activity is of little relevance to the wider economy, which is why direct interbank business is excluded from money supply definitions. Bearish analysis based on the fall in M4, in other words, should be ignored.