Eurozone monetary statistics for July confirm an improving economic outlook, with six-month growth rates of real M1 and M3 (i.e. deflated by consumer prices) reaching their highest levels since July 2010 and March 2009 respectively. Real M1 is the “best” monetary forecasting indicator of the economy, contracting before the 2008-09 and 2011-12 recessions and rebounding ahead of the intervening recovery – see first chart. It bottomed in April 2012, suggesting that the Eurozone economy will trough this autumn and revive into 2013, allowing for the usual half-year lead.
The turnaround in economic prospects is likely to be missed by a consensus focused on continued weakness in bank lending to the private sector. The money supply is picking up despite credit weakness because of recent bank purchases of government bonds and a shift of funds out of longer-term bank savings instruments into deposits. The latter trend should be sustained following further falls in interest rates and shows that these are working to change behaviour – a transfer of savings into more liquid forms is a precursor of higher spending. Bank buying of government bonds has slowed recently but the ECB’s planned intervention scheme may take up any slack. (Credit usually lags money – in 2008-09, private sector loans bottomed more than a year after M1.)
Real M1 rose by 2.2%, or 4.4% annualised, in the six months to July. M1 comprises currency in circulation and overnight deposits. The ECB provides a country breakdown of deposits but not currency. A 2.1% rise in Eurozone real overnight deposits in the six months to July reflects a strong 4.6% increase in “core” countries offset by a 2.1% decline in the periphery (i.e. Greece, Ireland, Italy, Portugal, Spain) – second chart. Within the core, German real overnight deposits surged by 6.3%, or 13.0% annualised, suggesting that the economy will boom next year – see previous post. French real deposits, by contrast, have contracted recently – third chart.
The continued fall in peripheral real overnight deposits is disappointing, signalling no end to recessions this year, but the decline has – Spain excepted – slowed. Recent and prospective ECB actions promise improvement, in part by lifting confidence, thereby stemming or reversing capital flight. Core / periphery monetary divergence is of less concern when Eurozone-wide real M1 is rising solidly – a gap is desirable to promote economic rebalancing.
The key risk in the current monetary constellation is that prospective German buoyancy results in the Bundesbank and its allies demanding that the ECB rein in stimulus, repeating the 2010-11 policy debacle that laid the foundations for the current recession. ECB President Draghi, however, has skilfully outmanoeuvred the hardliners by designing policies that command strong support – to the extent that the Bundesbank chief is now isolated even from Germany’s representative on the ECB’s executive board.