Monetary pessimists on Eurozone economic prospects cite recent weakness in broad money, M3 – down by 0.1% in the year to April. A detailed examination of the data, however, suggests that monetary conditions are consistent with an ongoing economic recovery and little risk of Eurozone-wide deflation:
- M3 has been depressed by a shift of funds into longer-term bank instruments – deposits with agreed maturity of over two years or subject to notice of over three months and securities of over two years' maturity. These instruments are excluded from M3 but would be captured by the UK's M4 definition, which includes all sterling deposits together with securities of up to five years' original maturity. A Eurozone M4-type measure rose by 1.7% in the year to April, above the latest annual growth rate of UK M4 of 1.2% (in March) – see first chart. (UK M4 here refers to the Bank of England's preferred definition, excluding money holdings of non-bank financial intermediaries.)
- M3 and M4 have picked up recently, rising by 3.3% and 2.9% annualised respectively in the latest three months.
- As in other major economies, with the exception of Japan, broad money demand of households and financial institutions has been reduced by negative real interest rates, so slow overall expansion has not prevented a strong recovery in corporate money holdings – M3 deposits of non-financial corporations rose by 6.1% in the year to April. With firms continuing to repay bank debt, one measure of the liquidity ratio (i.e. corporate M3 deposits divided by bank loans of up to five years' maturity) is at a record high – second chart.
- Narrow money M1 – comprising currency and overnight deposits – has been a better leading indicator of the economy than M3 historically and should be less affected by the recent shift in demand. It is still growing strongly – by 10.7% in the year to April and 9.8% annualised in the latest three months.
