Unusual UK monetary movements

Posted on Thursday, November 3, 2022 at 02:06PM by Registered CommenterSimon Ward | CommentsPost a Comment

UK monetary statistics for September were heavily distorted by cash-raising by LDI funds to meet collateral requirements for derivative contracts. 

The headline M4ex broad money aggregate surged by £91 billion, equivalent to 2.7% after seasonal adjustment, between end-August and end-September. Money holdings of non-bank financial corporations* accounted for £71 billion of this increase. 

The long-standing practice here has been to focus on non-financial monetary aggregates, where available, because movements in financial sector money holdings can be erratic and usually have little bearing on near-term economic prospects. 

Non-financial M4, encompassing money holdings of households and private non-financial businesses, rose by £21 billion, or a seasonally adjusted 0.3%, in September. Annual growth eased to 3.5%, with the aggregate expanding at an annualised rate of 3.2% in the latest three months – see chart 1. 

Chart 1

The Bank publishes an industrial breakdown of sterling deposits at commercial banks. The LDI cash-raising is reflected in large monthly increases in deposits of insurance companies, pension funds, fund managers and securities dealers (LDI funds posted margin to dealers, with the dealers placing the funds with banks). This group added a combined £39 billion to sterling deposits in September. 

However, the rise in aggregate deposits of non-financial corporations, according to this table (C1.1), was £46 billion in September – far short of the £71 billion increase in their total M4 holdings (A2.2.3). This represents a record divergence – chart 2. 

Chart 2

The “missing” funds show up on the Bank’s balance sheet: private sector sterling deposits held at the Bank jumped by £28 billion in September (B2.2.1), also a record movement – chart 3. 

Chart 3

Securities dealers and clearing houses have accounts at the Bank, which they appear to have used to deposit a portion of the margin cash received from LDI funds. 

Note that this increase in deposits is not attributable to the Bank’s gilt-buying operation, which started on 28 September: the Bank’s holdings of public sector securities fell by £5 billion during September. 

Sterling cash-raising related to the LDI crisis may have totalled about £67 billion – the sum of the £39 billion increase in commercial bank deposits of insurance companies, pension funds, fund managers and dealers and the £28 billion placed at the Bank. 

LDI funds were also scrambling to raise foreign currency liquidity. The rise in foreign currency deposits of the same group of institutions rose by £25 billion in September. 

Not all the cash-raising represents sales of assets – LDI funds were also borrowing to meet margin requirements. Sterling bank lending to the same group rose by £16 billion in September, with foreign currency lending up by £18 billion. 

Was the Bank involved in facilitating the supply of liquidity to the funds, over and above its gilt-buying operation? It is unlikely to have played a direct role but banks may have borrowed from its discount window to onlend to LDI funds. 

This possibility is suggested by partial data on the Bank’s sterling liabilities and assets – it no longer publishes a full balance sheet on a timely basis. Identified sterling liabilities, including bank reserves and the sterling deposits referred to earlier, rose by £14 billion, while assets – including gilt holdings – fell by £6 billion. The implication is that unpublished items on the balance sheet resulted in the creation of £21 billion of identified sterling liabilities, with discount window lending a candidate explanation. 

*Excluding intermediaries such as central clearing counterparties.

China update: money signal positive but policy / global risks

Posted on Friday, October 28, 2022 at 12:27PM by Registered CommenterSimon Ward | Comments1 Comment

Chinese money trends remain moderately favourable but the economy has been held back by covid disruption and now faces an export threat from global recession. Stocks, meanwhile, have been hit by a ramping up of the Biden administration’s war on Chinese tech along with President Xi’s take-over of economic policy-making, which investors have viewed as negative for longer-term growth prospects. “Excess” money has accumulated in the bond market and has the potential to flow into the economy and equities if the covid drag fades and policy-makers signal a continued commitment to private-led economic expansion. 

Six-month growth rates of nominal narrow and broad money have risen significantly over the past year, with the recovery reflected in a rebound in two-quarter nominal GDP expansion in Q3 despite further covid lockdowns – see chart 1. August / September numbers hint at a peak in money growth but continuing policy support, including directions to banks to expand lending, argues against a relapse – chart 2. 

Chart 1

Chart 2

The faster growth of money than GDP, and of broad money relative to narrow, indicates that the transmission of monetary stimulus is incomplete and “excess” money is currently trapped in the financial system. The key reason for the impaired transmission, of course, is the zero covid policy. With economic activity suppressed, excess money has flowed into the bond market, reflected in a fall in government yields despite the global surge and a tightening of onshore credit spreads – chart 3. 

Chart 3

The economy, nevertheless, has been less weak than many feared, as confirmed by the Q3 GDP number and September monthly activity data, showing a pick-up in industrial output and a stabilisation of new home sales – chart 4. A H1 fall in the interest rate on new mortgages and other easing measures are supporting housing market activity, with secondary sales reportedly growing strongly – chart 5. 

Chart 4

Chart 5

Retail sales remain weak but household money holdings are growing solidly, suggesting fire-power to lift spending if / when covid disruption eases – chart 6. 

Chart 6

Six-month growth of Chinese real narrow money contrasts with contractions in most major economies – chart 7. The level of growth, however, is modest by historical standards, suggesting moderate economic expansion at best: current growth, for example, has been consistent with a manufacturing PMI new orders index of about 50 – chart 8. 

Chart 7

Chart 8

Export weakness due to global recession could drag the PMI lower, as occurred during the GFC. The Chinese reading, however, would be expected to hold up relative to global PMI new orders, which may be heading to 40. 

The moderately positive message for economic prospects from real money trends is supported by a recent recovery in a composite leading indicator calculated here, which attempts to mirror the components of the OECD’s US leading indicator – chart 9. 

Chart 9

Eurozone monetary update: false hope from broad money

Posted on Thursday, October 27, 2022 at 11:00AM by Registered CommenterSimon Ward | Comments1 Comment

Eurozone money measures are giving mixed signals. Headline broad money M3 rose by a strong 0.7% in September, pushing six-month growth up to 3.3% (6.6% annualised), the highest since December. Narrow money M1, by contrast, contracted on the month, with six-month growth falling further to 1.8% (3.7% annualised) – see chart 1. 

Chart 1

Broad money reacceleration, on the face of it, suggests an economic recovery towards mid-2023 after a sharp winter recession. The judgement here, however, is that broad money numbers have been boosted by technical / temporary factors and intensifying narrow money weakness is a better representation of current monetary conditions and economic prospects. 

The six-month rate of change of real M3, it should be emphasised, remains negative, with consumer prices (ECB seasonally adjusted series) rising by an annualised 8.2% between March and September. 

The sectoral breakdown of the headline M3 / M1 numbers, moreover, shows a significant recent contribution from rising money holdings of financial institutions. This probably reflects cash-raising related to weak markets and is not an expansionary / inflationary signal for the economy. 

The forecasting approach here focuses on non-financial money measures where available, i.e. encompassing holdings of households and non-financial firms only. Six-month growth of non-financial M3 was 2.6% in September versus 3.3% for M3 and has shown a smaller recent recovery – chart 2. 

Chart 2

A further reason for playing down the broad money pick-up is that it is not explained by any of the conventional “credit counterparts” – credit to the private sector and government, net external assets and longer-term liabilities. The counterparts analysis shows a positive contribution from unspecified residual items, which behave erratically, suggesting a future reversal – chart 3. 

Chart 3

Solid growth of lending to the private sector has been the key driver of recent M3 expansion. The October bank lending survey, however, showed a further plunge in credit demand and supply balances, signalling a future lending slowdown or even contraction – chart 4. 

Chart 4

Statistical studies show that real non-financial M1 has the strongest leading indicator properties of the various money and lending measures. Its six-month rate of change remains at the bottom of the historical range, suggesting no economic recovery before H2 2023 – chart 5. 

Chart 5

UK recession gathering pace at end-Q3

Posted on Thursday, October 20, 2022 at 02:13PM by Registered CommenterSimon Ward | Comments1 Comment

A “monetarist” UK recession probability model used here signalled a 70% likelihood of a recession in 2022 back in March. Coincident data suggest that contraction began in the summer. The model now indicates that the recession will last through Q2 2023, at least. 

Monthly GDP figures have been affected by holiday distortions and are often revised significantly but current data show a peak in May and a 0.9% drop by August. 

Employment is a lagging indicator so further growth in the PAYE jobs measure (also subject to large revisions) through September does not preclude a recession having begun*. Job vacancies, by contrast, are coincident. The ONS vacancies series peaked in May, falling steadily through September. 

The published ONS series is a three-month moving average but single-month numbers are available on a non-seasonally-adjusted basis, to which an adjustment procedure can be applied. The resulting total vacancies series peaked in April, falling modestly through July before plunging in August / September– see chart 1. The suggestion is that economic conditions worsened sharply at the end of Q3. 

Chart 1

 

The decline in total vacancies reflects a larger fall in private sector openings, which were down by 13% in September from a May peak, offset by a further rise in the public sector driven by health and social care. 

The official vacancies numbers are from a survey of employers but the ONS also compiles weekly indices of online job adverts from data supplied by Adzuna. These indices have a short history and are not seasonally adjusted but the year-on-year change in total job adverts mirrors that of total vacancies – chart 2. 

Chart 2

Inputs to the recession probability model include real money measures, interest rates, credit spreads, share prices, house prices and the effective exchange rate – see previous post for more details. The model looks out three quarters and the probability estimate stood at 79% at end-Q3, suggesting that the economy will still be in recession in Q2 2023 – chart 3. 

Chart 3

House price strength was a moderating influence on the model reading until recently but coming weakness may contribute to the probability estimate remaining in recession territory. 

*The Labour Force Survey measure of employees in employment fell between May and July but recovered in August.

G7 inflation peaking on schedule

Posted on Wednesday, October 19, 2022 at 03:11PM by Registered CommenterSimon Ward | CommentsPost a Comment

The “monetarist” rule of thumb that monetary changes feed through to prices with a lag of about two years suggests that G7 consumer price inflation will fall steeply from early 2023. 

G7 headline annual CPI inflation, as calculated here*, moved back up to 7.6% in September, just below a June high of 7.7%. 

A QE-driven surge in G7 annual broad money growth in 2020-21 was similar in magnitude to a bank lending-driven surge in the early 1970s. A peak in money growth in November 1972 was followed by an inflation peak exactly two years later – see chart 1. 

Chart 1

The 2020-21 money growth surge was largely complete by June 2020, although the final peak occurred in February 2021. The expectation here is that the June 2022 peak in CPI inflation will hold but the two-year norm suggests that a big fall will be delayed until after February 2023. 

Annual broad money growth collapsed from February 2021, falling much faster and further than after the 1972 peak. Then, money growth bottomed above 10% in 1975 and rebounded into 1976, remaining in double digits until 1980. Sustained strength allowed high inflation to become entrenched. 

Annual broad money growth is now below 4% (September estimate), with QT plans and a likely credit crunch suggesting further weakness. 

Money growth was relatively stable between 2013 and 2018, averaging 4.3% pa. CPI inflation averaged just 1.2% over 2015-20 (i.e. allowing for a two-year lag). Current monetary weakness suggests similar or lower inflation outturns in 2024. 

While headline probably peaked in June, core inflation continued to rise into September – chart 2. Core strength is feeding pessimism about inflation prospects, but shouldn’t. Contrary to popular mythology, core usually lags headline at turning points. Base effects boosted the G7 core annual rate over July-September but turn more favourable from October through next May (seasonally adjusted, the core index rose by an average 0.44% per month over October 2021-May 2022 versus 0.19% over July-September 2021). 

Chart 2

*GDP-weighted, Japanese September CPI estimated from Tokyo data.

UK credit crunch arguing for QT cancellation

Posted on Friday, October 14, 2022 at 03:05PM by Registered CommenterSimon Ward | Comments2 Comments

Recent dramatic tightening of UK credit conditions along with Bank of England plans for large-scale QT and a “significant” rate hike could tip current weak broad money growth over into contraction, in turn threatening a deflationary depression. 

To recap, the preferred broad measure here – non-financial M4, comprising sterling money holdings of households and private non-financial firms – grew at an annualised rate of just 0.8% in the three months to August. 

The Bank’s broad measure, M4ex, also includes money holdings of financial institutions, which may rise sharply in September / October, reflecting pension funds’ “dash for cash”. Any such strength is not expansionary / inflationary, increasing the importance of focusing on non-financial money measures. 

In real terms, non-financial M4 has retraced almost back to its pre-pandemic trend as the 2020-21 money surge has passed through to prices – see chart 1. There is no longer a monetary “excess” to support spending or sustain high inflation. 

Chart 1

Current monetary weakness will take time to be reflected in slower price momentum. Prices may continue to outpace nominal money expansion near term, sustaining the real-terms squeeze. 

How likely is it that nominal broad money will begin to contract? 

The “credit counterparts” analysis links movements in broad money to changes in four other components of the banking system’s balance sheet: lending to the public and private sectors, net overseas assets and non-deposit funding. 

Lending to the public sector includes QE / QT. The Bank plans to reduce its gilt holdings by £80 billion over the next 12 months, equivalent to 3.4% of non-financial M4. 

The monetary drag will be smaller to the extent that there is a compensating rise in commercial banks’ gilt holdings. Banks bought £13 billion of gilts in the year to August. Purchases reached a maximum 12-month rate of £50 billion in the wake of the GFC when banks were under strong regulatory pressure to boost their liquid assets. A plausible scenario is that banks will absorb between a third and a half of the QT supply, in which case lending to the public sector would have a contractionary impact on broad money of 1.7-2.2% over the next 12 months. 

Bank lending to the private sector has been supporting broad money growth recently: lending to households and private non-financial firms expanded at a 3.1% annualised rate in the three months to August. The Bank’s Q3 credit conditions survey, released yesterday, signals weakness ahead: future credit demand balances remained soft while availability plunged – chart 2. 

Chart 2

The survey closed on 16 September so does not capture the further surge in market rates and spreads in the wake of the mini-Budget. 

Residential mortgages account for 70% of the stock of lending to households and non-financial firms. The future demand and availability balances for secured credit to households last quarter were comparable with the lows reached at the depths of the GFC – before recent turmoil. Mortgage approvals could halve – chart 3.

Chart 3

 

Bank lending expansion, therefore, could plausibly grind to a halt, as it did in the wake of the GFC. The combined monetary impact of public and private sector lending would then become contractionary.

The other credit counterparts – banks’ net overseas assets and their non-deposit funding – are volatile and difficult to forecast but have had a combined contractionary impact over the last 12 months. The joint influence, however, tends to correlate inversely with lending to the private sector, so could become supportive as lending weakens. 

The “best case” scenario appears to be weak broad money expansion with a significant risk of contraction. 

The warranted policy response is to cancel QT and rate hikes. The Bank, instead, has boxed itself into a restrictive stance in a misguided effort to rebuild its shattered credibility and avoid a charge of “fiscal dominance”. 

The hope is that a government U-turn on the mini-Budget together with an easing of global interest rate pressures result in a reversal of recent market-driven credit tightening. A Bank policy shift is coming but may have to wait for evidence of sharply contracting economic activity.