Global six-month industrial output growth was expected here to recover from mid-year, following a rise in real narrow money expansion in early 2014 and an accompanying firming of leading indicators. It appears, instead, to have fallen to a new low in August, based on available country data – see first chart. Has the expected revival been postponed or cancelled?
Note, first, that the further weakening into August is consistent with normal variation in the real money / activity relationship. Real money growth bottomed in November 2013 and leads turning points in output momentum by six months on average. The lead time in recent cycles, however, has extended as long as 11 months, suggesting that an output growth trough could occur as late as October 2014.
The extension of the global slowdown mainly reflects a further fall in G7 output growth – first chart. This, in turn, owes much to a continued production adjustment in Japan, where demand significantly undershot firms’ expectations following April’s sales tax hike – second chart. There is some similarity with the demand / output shock associated with the 2011 Tohoku earthquake, which exacerbated a "soft patch" in the global upswing.
The Japan effect may help to explain the recent divergence of industrial output data and business surveys. G7 manufacturing purchasing managers’ surveys strengthened between April and August, consistent with the growth revival scenario, but reversed much of the gain in September – third chart. There was a similar breakdown in the output / surveys relationship in 2011: the PMIs were overoptimistic at the start of the year but then weakened significantly even as activity rebounded.
One development consistent with an imminent output recovery is a pick-up in retail sales momentum through August – fourth chart. The positive divergence with output suggests that the stocks cycle is moving into a more favourable phase. Rises in the sales / output ratio are usually followed by a significant increase in output growth – fifth chart. An energy-driven fall in consumer price inflation may support retail demand near term.
The positive retail sales / industrial output divergence extends to Japan – sixth chart (showing levels rather than growth rates).
The favoured scenario of a near-term recovery in output growth will be maintained unless real money expansion or the longer leading indicator tracked here weaken notably. An August leading indicator reading will be available later this week. Global real narrow money growth fell in August but this mainly reflects a decline in the US, which appears to have reversed in September – see previous post.
The ECB today provided more details about its asset-backed securities (ABS) and covered bonds purchase programmes but gave no encouragement to forecasts that it will soon begin buying government bonds on a large scale. This may reflect a judgement that its actions since June coupled with a weaker exchange rate have delivered sufficient stimulus for now. More likely, the Governing Council remains deeply split on “full” QE.
The most important new information today was President Draghi’s statement that the “potential universe” of the ABS and covered bonds programmes is up to €1 trillion. The QE programmes in the US, Japan and UK have resulted in the respective central banks owning 19-26% of the stock of central government securities. Similar ECB ownership of the ABS / covered bonds universe would imply buying of €200-250 billion in total – lower than many estimates and equivalent to only 2.1-2.6% of annual GDP.
The ECB could buy a higher proportion of the outstanding stock and the universe is likely to expand as the central bank bids up prices. The former possibility, however, may be limited by liquidity considerations while the latter will take time.
With the new targeted longer-term refinancing operations (TLTROs) likely, at best, to offset the expiry of the 2011 / 2012 three-year repos over the next six months, ECB balance sheet expansion is likely to prove slow and it remains doubtful that President Draghi’s aim of an eventual return of assets to the early 2012 level – implying a rise of at least €600 billion – can be achieved without further initiatives.
Global six-month real narrow money growth fell sharply in August, based on data covering 90% of the aggregate followed here. September / October data should be awaited to assess whether this represents a genuine change of trend; if so, the suggestion is that the global economy will lose momentum in early 2015.
Six-month real narrow money growth picked up around end-2013 and remained solid through July, consistent with respectable economic expansion through end-2014, allowing for the usual half-year lead – see first chart. The August reading, however, was the lowest since May 2012, ahead of a significant slowdown in industrial output – see first chart.
The August fall in the global measure mainly reflected big declines in the US and China. Eurozone real money growth has firmed modestly, while Japanese weakness may be starting to reverse – second chart.
The focus now shifts to the global longer leading indicator monitored here, an August reading of which will be available on 8 October. This indicator typically leads the industrial cycle by 4-5 months and has yet to signal a peak in output expansion – third chart.
There is a reasonable chance that real money growth will rebound in September / October. US weekly data so far in September have partially reversed August weakness. Eurozone money trends may continue to strengthen in response to recent ECB policy easing. Lower energy costs should result in the six-month rate of change of global consumer prices falling temporarily, supporting real money growth. The six-month change in Japanese real money, meanwhile, should turn positive again in October as the April sales tax rise drops out of the calculation.
Eurozone money measures rose solidly again in August, suggesting improving economic prospects and initial success for the ECB’s June easing measures.
Broad money M3 rose by 1.0%, or 6.1% annualised, in July and August combined, while narrow money M1 surged by 1.9%, or 12.2% annualised.
Six-month growth of real (i.e. inflation-adjusted) narrow money M1 has risen from 1.6% (not annualised) in April to 2.6% in August, a solid pace by historical standards. Real M3 expansion has recovered from 0.1% to 1.2% over the same period, the latter reading being the highest since October 2012, ahead of an economic recovery in 2013 – see first chart.
The July-August M3 increase partly reflected a resumption of bank buying of government securities*, following the ECB’s June announcement of cheap fixed-rate funding via the TLTROs (targeted longer-term refinancing operations). M1 is driven by household and corporate demand for transactions money – the recent surge suggests rising spending intentions.
The ECB publishes a country breakdown of overnight deposits, comprising about 80% of Eurozone M1. The six-month rate of change of real deposits has strengthened in Spain and Italy, remained broadly stable at a solid level in France and Germany and weakened further in the Netherlands – second chart. These numbers can be volatile from month to month but narrow money growth appears to be on a higher trend across the periphery than in the core – third chart.
US six-month real narrow money growth was much higher than in the Eurozone at the start of 2014, signalling US economic and equity market outperformance. Current growth rates are similar, mainly reflecting a recent US slowdown.
*Bank purchases were €43 billion, seasonally adjusted, in July-August versus an M3 increase of €98 billion.
The August Inflation Report introduced a new reason for continuing to delay a rise in interest rates – the labour supply, it claimed, has been expanding faster than expected, explaining the recent puzzling combination of strong employment growth with weak wages, while implying still-significant economic slack.
This “theory” is viewed here as implausible, for two reasons. First, it is at odds with official labour force statistics, showing a rise of 0.9% in the three months to July from a year before, equal to the average annual growth rate since 2005. (The Bank's claim may have been influenced by a rise in annual growth to 1.7% in the three months to April, the most recent number when the Report was prepared; this partly reflected a favourable base effect and has since reversed.)
Secondly, a labour supply surge should have slowed the rate of decline of unemployment while helping employers to fill vacancies. The jobless rate, however, has fallen considerably faster over the last six months than during the previous half-year (1.0 versus 0.5 percentage points). The job openings rate (i.e. vacancies expressed as a percentage of filled and unfilled jobs), meanwhile, has continued to rise rapidly and is almost back to its pre-recession peak.
Weak earnings growth probably reflects two factors – problems with the official data and the normal lag between labour market quantities and wages. Surveys paint a stronger picture – the September Markit household finance index, for example, reports the joint-fastest rise in income from employment in its 68-month history. Interestingly, the latest MPC minutes refer to Bank research into the official data suggesting that workforce composition effects “have been pulling down on average wage growth, perhaps significantly”.
The first chart below shows average regular earnings growth and the job openings rate since 2001, when the current vacancies series begins. The relationship over this period suggests that earnings growth should already have risen substantially.
A longer look back, however, indicates that current developments are not so unusual. The second chart shows earnings growth and an earlier version of the job openings rate over 1970-90*. There were three large rises in the openings rate over this period. Earnings growth followed with a lag of between six and 12 quarters.
Returning to the recent past, the openings rate bottomed in 2009 but embarked on a sustained rise only in the second quarter of 2012. Based on the average nine-quarter lag following the three increases over 1970-90, this suggests an upswing in earnings growth starting in the third quarter of 2014.
The lack of movement of wage growth to date, therefore, is consistent with history but a significant pick-up is now likely. With the labour market continuing to tighten, moreover, the coming increase should be sustained into 2016, at least.
*Based on vacancies at Jobcentres.