Broad money supply and credit numbers have been boosted by the financial crisis and the Bank of England’s special liquidity scheme (SLS) has increased the distortion.

The money supply effect is the result of banks cutting back on traditional unsecured interbank lending in favour of various forms of secured loans. These secured loans are typically channelled through non-bank financial institutions, often bank subsidiaries, whose transactions are included in M4 and M4 lending.

The money holdings and bank borrowing of these “intermediate other financial companies” – to use the Bank of England’s terminology – have no implication for spending on goods and services and should be removed from the data for the purposes of monetary analysis. The effect is similar to “roundtripping”, which occurred in the 1980s when non-financial companies took advantage of interest rate anomalies to borrow from banks and redeposit the funds at a higher rate.

The distortion has increased since the introduction in April of the SLS, which has expanded the available pool of high-quality collateral against which banks can borrow and lend.

Headline M4 and M4 lending rose by 11.2% and 13.5% respectively in the 12 months to June. Stripping out intermediate OFC flows, the growth rates fall to 6.5% and 9.4%, according to the Bank of England.

In the second quarter alone, when the SLS was in operation, headline M4 grew at a 11.7% annualised rate but the adjusted measure is estimated to have risen by just 3%.

The level and pace of slowdown of adjusted M4 growth warrant consideration of an interest rate cut but the MPC is constrained by high and rising inflation expectations, sterling weakness and fiscal laxity, likely to be confirmed by the coming Pre-Budget Report.

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