UK real money squeeze suggesting late 2017 weakness
Wednesday, March 29, 2017 at 01:36PM
Simon Ward

UK narrow and broad money trends have weakened since the autumn, with rising inflation acting as a further drag on real-terms expansion. Allowing for the usual six to 12 month lag, this suggests that the economy will expand respectably through mid-2017 but slow sharply in the second half.

UK money trends are diverging negatively from those in the Eurozone. As noted in Monday’s post, annual growth of Eurozone narrow and broad money – as measured by non-financial* M1 and non-financial M3 – rose to 10.0% and 5.8% respectively in February, representing 16-month and eight-year highs. In the UK, by contrast, annual non-financial M1 growth peaked at 10.2% in September 2016 and fell to 8.6% in February, an 11-month low. Broad money growth – as measured by non-financial M4 – declined from 6.8% to 5.4% over the same period. The change of trend suggests that the recent pick-up in nominal GDP expansion will tail off and reverse later in 2017 – see first chart.

Shorter-term money trends signal a likely further decline in annual expansion. Non-financial M1 rose by 3.5%, or 7.2% at an annualised rate, in the six months to February, with non-financial M4 up by 2.0%, or 4.0% annualised. With consumer prices accelerating, six-month real growth of the two measures is the lowest since 2012 and 2011 respectively – second and third charts.

Why has money growth slowed? The demand to hold narrow money is influenced importantly by spending intentions, explaining why it leads the economy. Households and firms may be scaling back spending plans in response to Brexit uncertainty and rising prices / costs, with these negatives outweighing favourable global economic conditions. Real M1 holdings of households and private non-financial corporations (PNFCs) have slowed similarly, suggesting weaker prospects for both consumer spending and business investment – fourth chart.

Broad money fluctuations are viewed here as being driven by supply-side influences such as credit trends and balance of payments flows in the short run, with demand adjusting to supply further out. The recent slowdown appears to reflect a moderation of lending growth – second chart – and a rise in banks’ non-deposit funding. To the extent that the September-February QE programme had any positive impact, it was more than offset by other factors.

The MPC is now in a stagflationary bind of its own making. The failure to act to check rising money growth in 2015-16 suggests upward pressure on inflation through late 2018, at least – see previous post. Belated policy action, however, will be presentationally and politically difficult against the backdrop of a second-half economic slowdown suggested by real money trends.  A possible scenario is that the MPC will make a token reversal of its ill-advised August rate cut later in 2017 while relying on the Brexit excuse to deflect blame for poor inflation / growth outcomes and avoid a more significant policy adjustment.

*Non-financial = held by households and non-financial corporations (i.e. excludes financial sector money).

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