Annual growth of broad liquidity held by UK households and private non-financial corporations (PNFCs) rose from 6.1% in August to 6.2% in September, the fastest since June 2008. Corporate money, in particular, is surging, suggesting strong prospects for business spending. If the recent stability of the velocity of broad liquidity were to persist, sustained growth at the current pace would cause inflation to overshoot the 2% target over the medium term.
The strengthening of liquidity trends is underappreciated because most commentary focuses on the Bank of England’s M4ex* broad money aggregate, annual growth of which has remained at about 4% (3.9% in September) – see first chart. The increase in M4ex over the past 12 months, however, was depressed by 1) older savers switching out of bank deposits into National Savings (NS) pensioner bonds and 2) a fall in financial sector money. Neither development is of economic significance**.
A better guide to the availability of liquidity to finance private sector spending at present is the sum of M4 money held by households and PNFCs – i.e. “non-financial M4” – and outstanding NS. Of the 2.3 percentage point gap between the annual growth rates of this aggregate (6.2%) and M4ex (3.9%), about two-thirds is due to the NS effect and one-third to falling financial sector deposits.
The velocity of circulation of this liquidity measure has been broadly stable in recent years – see previous post. If velocity were to continue to move sideways, sustained 6% liquidity growth would be reflected, in time, in an equal rate of increase of national income. This, in turn, would imply inflation of about 3.5%, assuming 2.5% trend output expansion.
Annual growth of both corporate and household liquidity has risen over the past year but the former is much stronger – 12.4% versus 4.8%. Significant changes in corporate liquidity growth have foreshadowed economic fluctuations in recent years. Corporate liquidity contracted before the 2008-09 recession and the 2011-12 “double-dip” scare, but rebounded sharply in 2012 ahead of the positive GDP growth surprise in 2013 – second chart. The further increase in liquidity expansion this year casts doubt on the consensus forecast of slower GDP growth in 2016 than 2015.
The suggestion that monetary conditions have loosened, requiring an early policy response, is supported by still-robust expansion of narrow money, as measured by non-financial M1, and a continued pick-up in bank lending to households and PNFCs, annual growth of which reached 2.2% last month, the fastest since April 2009 – third chart. Leading indicators suggest further credit acceleration: mortgage approvals reached another post-recession high in value terms last month, while annual growth of arranged but undrawn credit facilities rose to 6.0%, the fastest since December 2004.
*M4ex = M4 excluding holdings of “intermediate other financial corporations”.
**The £11 billion fall in financial sector M4 in the year to September may partly reflect a switch from bank deposits to other liquid instruments: private-sector holdings of Treasury bills and other central government debt (mainly short-term repo borrowing by the Debt Management Office) rose by £8 billion over the same period.
