UK broad money growth remains sluggish but is probably consistent with trend economic expansion and a continuing inflation overshoot given a likely further rise in the velocity of circulation, partly due to negative real interest rates.
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The Bank of England's favoured broad money measure – M4 excluding money holdings of "intermediate other financial corporations", or M4ex – rose at an annualised rate of 2.1% between September and March compared with 1.2% in the prior six months, continuing the slow post-crisis trend.
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Annualised growth fell from 3.3% to 0.9% between the fourth and first quarters but this was partly due to financial corporations switching cash into foreign currency deposits excluded from M4ex, possibly in (correct) anticipation of sterling weakness. M4 holdings of households and private non-financial corporations (i.e. M4 excluding all financial corporations) rose by 2.6% annualised in the first quarter, up from 0.8% in the fourth.
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Slow broad money growth has not prevented solid expansion of nominal demand and GDP in recent quarters, i.e. the velocity of circulation has risen. Using the official adjustment for the impact of December's bad weather, GDP grew by 4.7% in the year to the fourth quarter versus a 1.9% rise in M4ex, implying a velocity increase of 2.7%. The economy's current travails reflect an unfavourable inflation / real growth split rather than insufficient nominal demand.
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The Bank of England has recently acknowledged arguments for expecting velocity to continue to increase (see a box in the February Inflation Report and an article in the latest Quarterly Bulletin), implying that an acceptable M4ex growth rate may now be well below the minimum 5% previously suggested. In the 1970s, when interest rates were last held beneath inflation for a sustained period, broad money velocity rose by 39% over six years, or almost 6% a year.
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Private non-financial corporations continued to repay bank borrowing during the first quarter but it is a stretch to argue that credit contraction is constraining the economic recovery. Companies have increased investment and hiring but have no need to borrow since net free cash flow is at a record high: the corporate financial surplus (i.e. retained earnings minus capital spending) reached 6.2% of GDP in the fourth quarter versus an average of 0.4% since 1963 – see first chart.
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Gilt holdings of banks and building societies fell by £2.4 billion in March but this reflected a large redemption and is unlikely to signal any reduction in underlying demand. Holdings have increased by £28.4 billion over the last five months, more than net gilt issuance of £26.9 billion over this period – second chart.
