Brexit-focused MPC ignoring weak money trends

Posted on Thursday, November 1, 2018 at 02:04PM by Registered CommenterSimon Ward | CommentsPost a Comment

Brexit uncertainty may at least have prevented the Bank of England from making another policy mistake.

Today’s MPC communications suggest that, absent the Brexit cloud overhanging economic prospects, the Committee would have hiked rates again to counter perceived inflationary risks from a tight labour market. Weak money trends, however, argue that policy settings are already restrictive and the next move may have to be to ease not tighten.

Annual growth rates of four different money measures fell further in September, to the lowest levels since 2012 – see first chart*. Consumer price inflation has also declined this year but by much less, so real money growth has slowed significantly.

The second chart compares annual growth of nominal GDP with that of the four money measures. The monetary slowdown since 2016 has been reflected in a slide in nominal GDP growth, ignoring a small recovery in the second quarter of 2018 (which could be revised away). With money trends still weakening, nominal GDP growth may move down further towards 2% in early 2019. The MPC needs to achieve average growth of about 3.5% per annum to meet the 2% inflation target, assuming potential output expansion of about 1.5% pa.

The monetary slowdown partly reflects policy tightening – the November 2017 / August 2018 rate hikes, closure of the term funding scheme in February 2018 and instructions to banks to conserve capital because of Brexit risk. In addition, Brexit uncertainty and slower-than-expected global growth have dampened business / consumer confidence and spending plans, resulting in a reduction in credit demand and lower desired holdings of transactions money.

Facing possibly significant Brexit-related volatility over coming months, the MPC could do worse than steer policy on the basis of monetary trends. That means eschewing any consideration of another rate hike until money growth recovers, and moving to an easing bias if trends continue to weaken.

*Non-financial = held by the household sector and private non-financial corporations. M1 = narrow money = sterling notes / coin and sight deposits. M4 = broad money = M1 plus sterling time deposits, repos and bank securities of up to five years’ original maturity. M4++ = non-official expanded measure = M4 plus foreign currency deposits, national savings and retail sales of unit trusts and OEICs. M4ex = Bank of England’s preferred broad money measure = non-financial M4 plus M4 holdings of financial corporations, excluding intermediaries.

Global monetary update: no recession signal

Posted on Wednesday, October 31, 2018 at 05:53PM by Registered CommenterSimon Ward | CommentsPost a Comment

Global narrow money trends continue to signal a weak economic outlook but have not deteriorated further since early 2018 – a recession warning, in other words, has yet to be issued.

Six-month growth of global (i.e. G7 plus E7) real narrow money moderated in September but, in broad brush terms, has moved sideways since reaching a low in February, remaining below its range over 2009-17. Allowing for an average nine-month lead, the suggestion is that six-month industrial output momentum will bottom out in late 2018 and stabilise at a weak level in early 2019 – see first chart. 

The expected economic slowdown is on track – G7 plus E7 six-month industrial output growth is estimated to have declined to a 26-month low in September, based on data accounting for two-thirds of the aggregate.

Narrow money trends have stabilised across the major economies: the six-month change in real narrow money is above its minimum over the last year in all the G7 plus E7 economies except Mexico and Korea. Real narrow money growth is relatively firm in Japan and Euroland and weak in the US (and China), casting doubt on the sustainability of recent US economic / equity market outperformance – second chart.

While the stabilisation of G7 plus E7 real narrow money growth is reassuring, trends have deteriorated further in smaller Far East economies suffering a triple squeeze from US rate hikes, China’s slowdown and tariff wars – third and fourth charts. These economies are too small to have a significant direct impact on global activity but associated financial stresses could contribute to an extension of the current “risk-off” move in markets, with negative feedback to monetary trends / economic prospects in the major economies.

     The two "monetarist" rules followed here for switching between global equities and US dollar cash recommended cash at end-September. The first rule, which prefers equities if G7 plus E7 six-month real narrow money growth is above industrial output growth, will move back into equities at end-October, since a positive gap was restored in August and appears to have been maintained in September – first chart.

As an aside, G7 plus E7 annual real narrow money growth remained below industrial output growth in August and, probably, September. A switching rule using annual growth rates would also have outperformed buy-and-hold significantly historically but by less than the rule based on six-month changes.

The second rule prefers equities if G7-only annual real narrow money growth is above 3.0%, its pre-GFC long-run average. Growth recovered in September but did not exceed this threshold, so this rule will remain in cash during November – fifth chart.

Profits taking strain of rising wage growth

Posted on Friday, October 26, 2018 at 10:56AM by Registered CommenterSimon Ward | CommentsPost a Comment

Recent inflation news is consistent with the view here that rising wage cost growth is having a greater impact on profit margins than core price trends.

G7 headline and core (i.e. ex. food / energy and large tax changes) consumer price inflation eased for a second month in September. The core rate remains near the top of its post-crisis range but the recent July peak only matched a 2012 high, when labour markets and wage pressures were much weaker – see first chart.

The headline / core gap probably peaked in July and is likely to fall further into early 2019, assuming that commodity prices remain at their current level – second chart.

The judgement here has been that firms would struggle to push through price increases against a backdrop of restrictive monetary conditions and slowing economic momentum.

The third chart compares annual growth rates of nominal GDP and narrow money for the G7 plus E7 grouping. Nominal GDP expansion probably peaked in the second quarter of 2018, the latest data point, with money trends signalling a sustained slowdown. Assuming stable or more likely rising wage growth, lower expansion of aggregate nominal income implies a slowdown or outright weakness in profits and / or employment. Profits should take the strain first, leading to subsequent employment cut-backs.

Euroland slowdown on track but money trends stable

Posted on Thursday, October 25, 2018 at 12:32PM by Registered CommenterSimon Ward | CommentsPost a Comment

Euroland narrow money trends signalled the current economic slowdown and now suggest that momentum will stabilise at a weak level in early 2019.

Six-month growth of real narrow money, as measured by non-financial M1 deflated by consumer prices, peaked in June 2017 and fell sharply through April 2018, reaching a five-year low. Allowing for a typical nine-month lead, this suggested that two-quarter GDP growth would top out in early 2018 and decline through year-end.

The slowdown, in the event, started slightly earlier, possibly reflecting euro strength during 2017. Two-quarter GDP expansion fell from 1.3% in the fourth quarter of 2017 to 1.1% in the first quarter of 2018 and 0.8% in the second quarter – see first chart.

Purchasing managers’ surveys signal a further loss of momentum since mid-year. The October flash reading of the composite output index is consistent, according to the survey compiler, with GDP expansion of only 0.3% per quarter.

Money trends, however, have stabilised since early 2018, with six-month real narrow money growth slightly higher in September than at end-2017. Real broad money – non-financial M3 – expansion has also edged up.

This may prove to be a pause before further deterioration but the implication is that GDP momentum will stabilise at a weak level in early 2019, in which case purchasing managers’ indices may find a bottom soon, although a recovery is unlikely.

The expectation here remains for GDP to rise by 0.25-0.35% per quarter, below the September ECB staff central forecast of quarterly growth of 0.4% in the second half of 2018, rising to 0.5% during 2019 – such a reacceleration now seems wildly unrealistic.

The Italian fiscal crisis and associated rise in the sovereign yield spread have yet to be reflected in any relative weakness of Italian money trends. Six-month growth of real non-financial M1 deposits was similar across the big four economies in September – second chart.

Chinese money trends stabilising, outlook still weak

Posted on Tuesday, October 23, 2018 at 12:11PM by Registered CommenterSimon Ward | CommentsPost a Comment

Chinese money and credit trends appear to be starting to respond to policy easing but a further recovery is needed to warrant shifting away from a negative view of economic prospects.

GDP and other activity data released last week confirm that the economy continued to lose momentum during the third quarter. Six-month growth of narrow money*, however, rebounded last month, reaching its highest level since February – see first chart.

Total social financing (TSF) also accelerated, reflecting heavy issuance of local government special bonds, used to finance investment – such bonds were added to the TSF definition this month, with data backdated to January 2017. TSF growth on the former definition remained soft in September, probably partly reflecting local government issuance “crowding out” other financing – first chart.

The apparent bottoming out of money / credit growth suggests a future stabilisation of economic momentum but there is no signal yet of a meaningful rebound. Even if money trends continue to improve, economic growth is unlikely to revive before the second quarter of 2019 at the earliest.

Experience in 2015-16 is cautionary: six-month growth of narrow money was at a similar level in April 2015 and subsequently surged into double-digits (not annualised) but a significant pick-up in two-quarter nominal GDP expansion was delayed until the second quarter of 2016 – first chart.

Increased local government issuance / spending has contributed to a recovery in public sector fixed asset investment, the annual change of which turned positive in September – second chart. Further strength, however, could be offset by a slowdown in housing investment: housing floor space sold was down last month from a year ago, while starts lost momentum – third chart.

Recent and prospective increases in US import tariffs are an additional headwind, while the extent of a rebound in money growth remains unclear, with the authorities still reluctant to sanction full reopening of the credit taps. Such action, moreover, could result in a further increase in capital outflows, dampening the monetary impact and adding to downward pressure on the currency. The forward discount on the offshore yuan suggests that outflows have remained elevated so far in October – fourth chart.

An optimistic view is that significant income tax cuts implemented this month and further reliefs announced over the weekend to take effect in January 2019 will boost consumer spending growth; an acceleration of household demand deposits from October would lend support to this scenario.

Other leading indicators suggest near-term further economic weakness. A composite leading indicator proposed in a previous post as an alternative to the OECD’s measure continued to fall in September, signalling below-trend economic expansion – fifth chart.

*True M1 = official M1 plus household demand deposits. Official M1 = currency in circulation plus corporate demand deposits.