The acceleration phase is over but monetary trends suggest that UK economic growth will remain solid through summer 2014.

The forecasting approach here focuses on the six-month rate of change of real narrow money, as measured by non-financial M1 deflated by consumer prices. This turned positive in late 2011, about six months before the economy began to show signs of life – see chart. Real money expansion continued to rise strongly during 2012, peaking in early 2013, since when it has eased slightly. GDP growth, accordingly, stabilised in late 2013 and may run at a slightly lower but still strong pace during the first half of 2014.

Current official data show GDP rising at a 3.0% annualised rate during the second half of 2014 (i.e. between the second and fourth quarters) but this is likely to be revised up, possibly to 3.5-4.0% – see Tuesday’s post. Based on the minor slowdown in real money expansion, GDP growth could run at about 3% during the first half of 2014. Weak productivity trends suggest that potential output is rising by less than 2% per annum, so 3% actual expansion would imply significant additional pressure on supply capacity, with attendant inflationary risks.

The message from narrow money is supported by the broader M4 measure. Real non-financial M4 growth also picked up in 2011-12, stabilising since early 2013. The current level remains low by recent historical standards but has been sufficient to support rapid economic expansion because the velocity of circulation has risen, as negative real interest rates have reduced the savings demand to hold money.

To repeat, the fundamental drivers of economic resurgence have been a reversal of the 2010-11 inflation spike and falling bank funding costs since mid-2012 due to Eurozone financial stabilisation and the funding for lending scheme. Falling inflation has lifted real money growth while lower deposit interest rates have encouraged consumers and firms to spend monetary savings, reflected in the switch from M4 into M1 and rising M4 velocity.

Faster economic growth is not, in other words, due to QE, reduced fiscal drag or a credit-driven consumer splurge. The latter hypothesis is particularly fanciful – lending to individuals rose by just 1.3% in the 12 months to December, implying that the household debt to income ratio continues its trend decline. The “creditist” argument that no economic improvement was possible without a prior pick-up in bank lending has been comprehensively demolished by recent events yet commentators continue to pore over credit tea leaves while ignoring the money supply.