A post in February suggested that the Euroland manufacturing PMI, then still strong at 58-59, would fall towards the 50 level by mid-2018. The decline has taken longer than expected but the PMI eased further to 51.4 in December (with assistance from the gilets jaunes). The composite manufacturing / services output index slid to 51.3, a four-year low. What now?

The basis for the February forecast was a significant fall in six-month real narrow money growth from June 2017 and an expectation that this would be reflected in PMI results with a lag of about six months. The chart, an update from the February post, illustrates this relationship, which now suggests that the PMI will stabilise around the 50 level through April 2019, based on monetary data through October 2018*.

Current money trends are judged here to be consistent with GDP growing by about 0.3% per quarter in the first half of 2019 – see previous post. Surprisingly, the new ECB staff forecast released yesterday maintained the previous central projection of 0.5% per quarter despite recent negative news. The suspicion is that a downgrade was postponed to avoid calling into question the decision to end QE. (Even more remarkably, the forecast commentary made no mention of the risk of a disruptive / disorderly Brexit.)

It should be emphasised that money trends – broad as well as narrow – are not signalling economic stagnation or contraction. The six-month change in real narrow money turned negative ahead of the 2008-09 and 2011-12 recessions. It stood at 2.4% in October.

The manufacturing PMI would need to fall to around 45 to suggest a GDP recession.

It has been claimed that the cessation of QE will lead to a “mechanical” further slowdown in money growth. Cross-country evidence, however, shows that the relationship between QE and money trends has been weak. Euroland money trends were improving well before QE started in 2015, probably reflecting rate cuts and expanded ECB lending to banks. Proponents of a “mechanical” relationship wrongly suggested that Japanese broad money growth would soar following the expansion of QE in 2013 – it barely budged.

The view of economic prospects here remains on the pessimistic side of the consensus but money trends do not currently warrant a further downgrade. Relative money trends suggest that downside risks are now greater in the US and China.

*The chart uses the EU Commission manufacturing survey as a proxy for the PMI before 2016 because of lack of access to historical data.