Cuts in interest rates reduce the opportunity cost of holding money in more liquid forms. Narrow money M1 – currency and checkable deposits – usually picks up relative to broader measures like M2 and M3. This is a sign that the change in interest rates is affecting behaviour and often precedes a recovery in economic activity.
US real M1 typically leads turning points in the economic cycle by 6-12 months – see first chart. Its annual rate of change bottomed in May and moved up sharply in September and October. Recent figures may have been artificially boosted by a flight of cash from money market funds. However, a further recovery in November and December would suggest an approaching trough in economic activity.
Eurozone figures released today also show M1 picking up, with a particularly large rise in October – see second chart. UK data will be available on Monday.
Note that M1 – unlike the monetary base – does not include bank reserves held at the central bank, so is not directly affected by “quantitative easing”.
