A simplistic growth forecasting rule based on the money supply and share prices – a rule that correctly predicted that the economy would beat expectations in 2013 – suggests that 2014 will be another strong year; GDP is projected here to rise by about 3%.
The forecasting rule assesses growth prospects for the coming calendar year based on whether December levels of real (i.e. inflation-adjusted) money supply growth and share prices are higher or lower than 12 months earlier. Real money growth is measured by the annual rate of change of the narrow M1 aggregate deflated by the retail prices index (RPI). Share prices are measured by the domestically-orientated FT30 index, again deflated by the RPI.
Annual GDP growth averaged 2.5% in the 47 calendar years from 1966 to 2012. The forecasting rule gave a “double-positive” signal in 23 of these years (i.e. both real money growth and share prices at the end of the prior year were higher than 12 months before). GDP growth in these years averaged 3.8%.
There were, by contrast, 15 years when the forecasting rule gave a “double-negative” signal. Growth in these years averaged just 0.4%. In the remaining 9 cases where the money supply and share prices gave conflicting signals GDP expansion averaged 2.5%*.
As noted, the forecasting rule predicted that the economy would perform well in 2013 – the December 2012 real level of the FT30 index was up by 16.8% from a year earlier, while the annual change in real M1 was 3.6% versus -4.9% in December 2011. GDP is currently estimated to have risen by 1.8% in 2013 but the increase was 2.7% measured from fourth quarter to fourth quarter. Upward revisions are likely.
The rule also outperformed the consensus in 2012: a double-negative signal was given at the end of 2011, ahead of growth of only 0.3% in 2012 and associated double / triple dip scares. A prior double-negative was issued at end-2008; GDP slumped by 5.2% in 2009.
Both conditions are still positive for 2014. The FT30 index in December 2013 was 24.7% higher than a year before, implying a real gain of 21.5% allowing for December RPI inflation of 2.7%. Annual real M1 growth, meanwhile, was 7.4% versus 3.6% at end-2012**.
The forecast here of GDP growth of about 3% in 2014 is beneath the 3.8% average for double-positive years. This partly reflects a judgement that weak productivity performance has lowered potential output growth to below 2% per annum currently versus a long-run average of about 2.5%.
*Using a broad rather than narrow money measure produces similar results. For example, a rule based on non-financial M4 (i.e. M4 held by households and private non-financial corporations) yields average GDP growth in double-positive years of 3.9% (16 years) and in double-negative years of 0.7% (11 years).
**Broad money signals differ according to the aggregate used. Real growth of M4 and non-financial M4 was higher in December 2013 than December 2012 but that of M4ex (i.e. M4 excluding holdings of financial intermediaries) was lower (1.0% versus 1.9%). GDP growth has averaged 2.6% in previous years with positive stock market and negative M4ex signals.
UK money measures that correctly predicted recent economic strength suggest stable, solid GDP expansion through summer 2014 at least.
Real non-financial M1 – currency and sterling sight deposits held by households and private non-financial firms, deflated by consumer prices – rose by 4.5% (not annualised) in the six months to January. Growth has been stable since spring 2013 and is well above the long-run average – see first chart.
Real non-financial M4, including time deposits and savings accounts, rose by a smaller 1.4% in the latest six months. Its growth has also been stable since last spring but is beneath the long-run average. This shortfall is not a constraint on economic expansion because the velocity of circulation is now rising*, partly reflecting the impact of negative real interest rates on the demand to hold broad money.
The six-month rates of change of the two real money measures bottomed in April 2011, rising over the subsequent two years to peak in April 2013. Underlying two-quarter GDP expansion (i.e. excluding North Sea production and adjusting for special bank holidays and the Olympics) bottomed in the first quarter of 2012 and rose through the third quarter of 2013, stabilising in the fourth quarter. This is consistent with the monetarist rule that (real) money supply changes lead demand and output by about six months.
Stable real money trends since last spring suggest that GDP will continue to grow by about 0.75% per quarter through the third quarter of 2014.
The consensus focuses on credit trends, neglecting that credit lags the economy whereas the money supply leads. The six-month rate of change of real non-financial M4 lending was consistently negative between June 2009 and November 2013, helping to explain consensus bearishness on the economy – second chart. It has recently turned marginally positive but this development contains no information about economic prospects.
*The ratio of nominal GDP to non-financial M4 (lagged six quarters) rose by 0.7% per annum between the second quarter of 2009 and the fourth quarter of 2013 versus a 3.2% pa decline over the prior 10 years.
Eurozone real non-financial M1* – the best monetary leading indicator of the economy, with a flawless track record in recent years – continues to signal improving prospects. Real money expansion is now stronger in peripheral economies than the core.
Six-month growth of real non-financial M1 rose to 3.7% (not annualised) in January, equalling November’s result, which was the strongest since February 2010. The six-month change turned negative before the 2008 and 2011 recessions and positive before the 2009 and 2013 recoveries – see first chart. The recent pick-up suggests that industrial output and GDP growth will firm through the late summer (at least).
The ECB publishes country data on overnight deposits, which dominate swings in M1. Six-month growth of real deposits in the peripheral grouping** rose to 3.8% in January versus 2.2% for the core – second chart. Peripheral expansion was lower than in the core in every month between September 2008 and October 2013.
The groupings conceal significant country variation, with Spain now the strongest of the big five, followed by Germany / Italy. French growth is modest but still consistent with an ongoing economic recovery; negative risks are greater in the Netherlands – third chart.
*Notes and coin in circulation plus overnight deposits of households and non-financial corporations divided by consumer prices, seasonally adjusted.
**Greece, Ireland, Italy, Portugal and Spain.
The official estimate of fourth-quarter GDP growth has been maintained at 0.7%, although revisions to earlier quarters have resulted in the annual increase falling from 2.8% to 2.7%. As expected here, services output undershot the 0.4% December rise assumed in the preliminary GDP estimate (increasing by 0.2%); the impact on the quarterly GDP rise, however, was offset by upward revisions to earlier months.
The key takeaway from the details of today’s report is that recent solid growth has been broadly based and balanced, increasing confidence in its sustainability. Consumer spending rose by less than GDP in the year to the fourth quarter – 2.4% versus 2.7%. Investment, meanwhile, soared by 8.7%; business fixed capital formation grew by 8.5%, with a stronger rise in housing investment*. Net exports were little changed over the four quarters – import penetration**, encouragingly, fell. The only negative in the expenditure breakdown was relatively high stockbuilding during the second half of 2013; the stockbuilding numbers, however, incorporate a balancing adjustment and are often revised significantly.
Solid growth is occurring across sectors and most activities: output of services, industry and construction rose by 2.7%, 2.3% and 4.3% respectively in the year to the fourth quarter. Services strength does not reflect finance – output of “financial and insurance activities” actually fell by 1.8% in the latest four quarters, subtracting 0.2 percentage points from GDP growth.
The income breakdown shows a 3.9% nominal rise in total employee compensation – including employers’ social (pension) contributions – in the year to the fourth quarter. The number of employees increased by 1.1% over the same period, according to last week’s labour force survey. So average compensation grew by 2.8% – more than CPI inflation of 2.1% in the fourth quarter***.
Adding in profits and other income, nominal GDP rose by an annual 4.4% in the fourth quarter. With potential output probably growing by less than 2% per annum, this rate of increase is incompatible with achievement of the 2% inflation target over the medium term.
*The difference between total and business investment suggests that the housing component grew by about 12%.
**The import share of domestic demand.
***A fourth-quarter breakdown between wages / salaries and employers’ social contributions is not yet available.
A large rise in US narrow money in the first week of February was only partially reversed the following week. The recent pick-up, if confirmed, suggests improving economic prospects for the second half of 2014.
Bad weather has exaggerated weakness in recent economic data but a slowdown had been expected here, partly reflecting softer monetary trends during the first half of 2013. Six-month growth of real narrow money* fell from 7.4% (not annualised) in December 2012 to 2.7% in June 2013.
Real money expansion, however, stabilised after mid-2013 and picked up to 4.7% in January. Data for the first two weeks of February imply a further increase to 5.5% or more. Underlying economic growth may remain soft through mid-2014 but second-half prospects appear to be brightening.
The chart incorporates a US February estimate along with January and December numbers for Japan and the Eurozone / UK respectively**. US real money expansion fell back into the middle of the pack in 2013 but is now diverging positively again, suggesting economic and equity market outperformance.
Narrow money is held mainly for transactions purposes and changes usually occur ahead of spending variations, explaining its leading properties. US spending plans, in other words, seem to be firming despite QE “tapering”, supporting the view here that QE changes have weak economic effects except under conditions of extreme financial stress.
*Currency plus demand deposits divided by consumer prices.
**January data for the Eurozone and UK are released on 27 February and 3 March respectively.