August monetary statistics are encouraging, suggesting a continued economic recovery and arguing against "QE2":
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The Bank's preferred broad money measure, M4ex (i.e. M4 excluding money holdings of "intermediate other financial corporations"), rose by a chunky 0.8% in August and has grown at a 4.5% annualised pace over the last three months.
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Within M4ex, money holdings of private non-financial corporations (PNFCs) gained 0.9%, pushing annual growth up to 5.0%. The corporate liquidity ratio – sterling and foreign currency deposits divided by borrowing – rose to its highest level since the second quarter of 2007. Excluding property companies, the liquidity ratio is close to the top of its range in recent years, supporting hopes of a further pick-up in business investment and hiring – see chart.
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M4ex lending rose by 0.3% following a 0.3% gain in July, resulting in three-month growth turning positive (0.8% annualised). This improvement mainly reflects financial-sector credit but lending to PNFCs also rose marginally in August.
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The QE2 crew will point to still-low annual growth in M4ex – 1.6% last month after 1.2% in July. They neglect that broad money velocity is rising fast – by 4.3% in the year to the second quarter, allowing nominal GDP to expand by 5.7%. When real interest rates were last negative for a sustained period in the 1970s, velocity rose by a cumulative 38.6% over six years, or 5.6% annualised. A similar trend is plausible now, suggesting that broad money expansion of 1-2% per annum is more than sufficient to finance sustainable economic growth of about 2.5% with 2% inflation.
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Monetary expansion continues to be supported by an influx of foreign funds – overseas investors bought £9.5 billion of gilts and Treasury bills in August, bringing the year-to-date total to £62.1 billion, while "monetary financial institutions' externals" contributed £15.1 billion to the increase in M4.
