Detailed monetary statistics for August released by the Bank of England yesterday suggest a further deterioration in near-term economic prospects. In particular:
- M4 excluding money holdings of financial corporations rose by 5.4% in the year to August, the lowest annual growth rate since 2000 and barely higher than retail price inflation of 4.8%. The increase in the three months to August was just 3.3% annualised.
- Narrow money M1, comprising currency holdings and sight deposits, was 0.6% lower in August than a year before, the first annual decline since 1969.
- M4 held by private non-financial corporations (PNFCs) fell for the fifth month out of the last six and is now down 2.8% from a year ago. With bank lending to PNFCs continuing to rise, the corporate liquidity ratio – money holdings divided by borrowing – reached its lowest level since 1991.
- Public sector deposits with UK banks rose by £18 billion in August, offsetting a £16 billion decline in interbank deposits. There may be an innocent explanation but this suggests covert official support for one or more struggling banks.
M4, M1 and the corporate liquidity ratio are inputs to my recession probability model, designed to estimate the chances of an annual decline in GDP three quarters ahead. Also taking into account recent upward pressure on unsecured interbank interest rates and credit spreads, the model now suggests a 55% chance of an annual fall in GDP by the second quarter of 2009 – see first chart.
While above 50%, the probability estimate is still significantly lower than the 80% plus levels reached before the last three recessions. The model projects an annual GDP decline of 0.2% in the second quarter of next year, implying a stagnant or mildly contracting economy rather than a full-scale downturn – see second chart.
According to the model, the outlook is less negative than before prior recessions because of a smaller rise in interest rates and the large fall in the effective exchange rate over the last year, which will support net exports. The latter effect is already evident: trade contributed 0.5 percentage points to GDP growth between the fourth and second quarters.
Incidentally, revised GDP figures released today support my view that the economy had not entered a recession before recent financial eruptions. Excluding volatile oil and gas production, output edged 0.05% higher in the second quarter. Available evidence suggests activity remained broadly flat in July and August.
