A rise in UK money growth over the past year signals faster nominal GDP expansion over coming quarters. The Brexit uncertainty shock and associated sterling weakness suggest that higher inflation will drive the pick-up, although output growth is also likely to exceed consensus expectations.

The chart shows annual growth rates of nominal GDP and the narrow / broad money measures tracked here – non-financial M1 and M4 – along with the Bank of England’s M4ex broad measure*. A directional leading relationship is apparent between non-financial M1 growth and nominal GDP expansion. The relationship is looser but still visible for the broader measures, with non-financial M4 outperforming M4ex.

Annual growth rates of non-financial M1, non-financial M4 and M4ex have been rising since June 2015, February 2015 and November 2014 respectively. Consistent with the “monetarist” relationship, nominal GDP expansion has recovered from a low reached in the third quarter of 2015. The lead time between non-financial M1 growth and nominal GDP expansion has averaged 7.5 months at the four turning points since 2010, suggesting that nominal GDP will continue to accelerate through early 2017, at least.

The pick-up in annual growth of the Bank’s M4ex measure was modest until May, reflecting falls in money holdings of financial corporations, i.e. fund managers, insurance companies / pension funds, securities dealers etc. These holdings, however, have surged at a 70.0% annualised rate over the past three months, pushing annual growth of M4ex above that of non-financial M4.

The prospect of a further rise in nominal GDP growth casts doubt on the wisdom of the MPC’s recent easing moves. The decision to launch more QE with M4ex growing by 6.9% annually and at a 14.7% annualised pace in the latest three months is particularly questionable. The MPC is, in effect, gambling that the Brexit shock will cause the recent monetary pick-up to reverse but there was no sign of weakness in the July-only data.

*The non-financial measures cover holdings of households and private non-financial firms. M1 = notes / coin plus sterling sight deposits. M4 additionally includes sterling time deposits, money funds, repos and short-term bank securities. M4ex = non-financial M4 plus M4 holdings of non-bank financial corporations, excluding intermediaries.