Solid Eurozone October money numbers support the view here that the economy will outperform gloomy consensus expectations next year – GDP could grow by 1% plus rather than contract by 0.1%, as forecast yesterday by the OECD. Monetary strength, however, remains focused on Germany and its satellites, with trends still weak in Spain and Italy.
Both broad and narrow money surged in October – M3 and M1 rose by 1.2% and 1.3% respectively on the month*. Real (i.e. CPI-adjusted) M1 is the best monetary leading indicator of the economy, outperforming real M3 and private sector credit, both of which failed to predict the 2008-09 recession. The six-month change in real M1 was negative as recently as April but rose to 4.6% (i.e. 9.5% annualised) in October in lagged response to the massive policy easing engineered by ECB President Draghi since late 2011 in the teeth of Bundesbank opposition. This is the fastest since December 2009 and a level historically associated with solid subsequent economic expansion – see first chart.
Consensus commentary is likely to ignore the upbeat message from M1, focusing instead on stagnant private sector bank loans. It is, however, normal for M1 / M3 to diverge positively from lending in the early stages of economic upswings – money leads the cycle whereas credit is, at best, a coincident indicator. The strong M3 rise in October, despite flat private sector lending, reflected a combination of an overseas inflow, central governments running down their cash holdings and a switch out of longer-term bank liabilities (e.g. bank bonds) into M3 deposits. Faster recent growth of M1 than M3 is interpreted here as signalling that households and firms are increasing holdings of “transactions money” ahead of a rise in spending.
Eurozone-wide real M1 predicted the recent recession but the country detail** also correctly signalled a wide divergence in economic performance between the core and periphery. The news here is less encouraging: the recent pick-up in real M1 deposits has been focused on the narrow core (i.e. Germany, Benelux and Austria), with France stagnant and contraction continuing in Spain and Italy – second chart. The suggestion is that the coming Eurozone recovery will be unbalanced, with “too much” growth in a resurgent Germany but too little in the other “big four” economies. There is, however, a glimmer of hope for two of the bailout countries: Portugal joined Ireland in recording a six-month rise in real M1 deposits in October – third chart.
*The rises in M3 and M1 may have been artificially inflated by the initial capital subscriptions, totalling €32 billion, paid by governments to the European Stability Mechanism (ESM). This would be the case if the ESM has been classified as part of the non-MFI, non-central government sector – the ECB’s “monetary developments” press release provides no guidance on this issue. If so, “underlying” increases in M3 and M1 in October will have been 0.8% and 0.7% respectively, i.e. still healthy.
**M1 comprises physical cash and overnight deposits. A country breakdown is available for deposits but not cash.
