UK real money growth has stabilised at a level suggesting solid second-half economic expansion.

The favoured broad and narrow aggregates here are non-financial M4 and M1, comprising holdings of households and private non-financial firms. These measures rose by 2.6% and 5.7% respectively in the six months to June, or 5.2% and 11.7% annualised. This represents significant real expansion since consumer prices rose by 1.0% after seasonal adjustment, or 2.1% annualised, over the same period – see first chart.

Following real contraction in 2011, non-financial M4 and M1 growth crossed above inflation at the start of 2012, signalling an economic recovery from mid-2012, allowing for the usual half-year lead.

Broad money growth remains modest by pre-crisis standards but is unlikely to be “too low” because the demand to hold money is being depressed by negative real deposit interest rates. It is the difference between the supply of money and the demand to hold it that determines whether economic activity / inflation will rise or fall.

Put differently, the MPC would guarantee an inflation overshoot if it were to commit to maintaining rock-bottom official rates until broad money expansion rose to an historically-normal rate of 7-8%*.

Much faster expansion of M1 than M4 is viewed here as evidence that households and firms are deploying monetary savings in the economy – funds have been moved from savings to current accounts to finance higher spending and financial investment. Such a shift has been encouraged by a further collapse in savings deposit rates over the last year, partly due to the funding for lending scheme. The M1 / M4 divergence, in other words, suggests a rise in the velocity of circulation.

Despite the suspension of formal QE last November, non-financial M4 rose at similar rates in the first half of 2013 and second half of 2012, i.e. 5.2% annualised versus 5.9%. This is consistent with the view here that QE had only a small positive impact on monetary growth. Broad money trends have been supported recently by a reduction in banks’ wholesale funding (i.e. net external and foreign currency borrowing and sterling non-deposit liabilities). For a given stock of sterling bank lending to the UK private and public sectors, a cut in such funding leads to a rise in M4.

Private-sector lending fell slightly in June but may expand in the second half – credit is usually a coincident or slightly lagging indicator of the economy. Arranged but unused sterling credit facilities rose by 4.4%, or 9.0% annualised, during the first half – second chart.

*Non-financial M4 grew at an average annual rate of 7.7% in the 10 years to December 2007.