Chinese monetary and regulatory policy tightening in 2017 has raised fears of a sharp economic slowdown in 2018. Monetary trends do not currently support such worries. Narrow and broad money measures are rising at a pace consistent with moderate nominal economic expansion*. An easing of inflationary pressures could allow the authorities to step off the policy brakes in the first half of 2018, assuming that the currency remains stable.

Policy was tightened from late 2016 to cool excessively strong nominal economic growth and discourage capital outflows, which were threatening currency stability. Six-month growth rates of narrow and broad money fell significantly through spring 2017, with this slowdown subsequently reflected in a moderation in nominal GDP expansion – see first chart.

Narrow money growth has fallen slightly further in recent months but remains at a respectable level by historical standards and far above levels reached in late 2014 / early 2015, ahead of significant economic weakness. Broad money growth was worryingly low in the summer but has recovered to match narrow money expansion.

Based on these trends, previous posts (e.g. here) suggested that nominal GDP expansion would stabilise in late 2017 / early 2018. November activity and price data are consistent with this forecast: the product of industrial output and producer prices is a rough proxy for nominal GDP and its growth has revived since the summer – second chart.

Annual narrow money growth leads trends in annual growth of house prices, industrial profits and producer prices – third chart. With money growth still cooling, house prices are likely to slow further in the first half of 2018, while producer price inflation should moderate. The authorities may respond by partially reversing recent policy tightening, assuming that the balance of payments position remains stable. Such a reversal could support commodity prices despite restrained economic expansion.

*The preferred narrow and broad money measures are M1 plus household demand deposits (referred to here as true M1) and M2 minus financial sector deposits plus bank bonds. The exclusion of household deposits from the official M1 measure suggests that it will not adequately reflect consumer spending prospects. Financial sector M2 deposits have shown significant volatility in recent years but appear to contain little information about near-term economic prospects. A switch out of time deposits into bank bonds, meanwhile, may have depressed M2 growth.