Better monetary trends from mid 2011 signalled the recent recovery in UK “underlying” economic growth. March monetary statistics suggest that this recovery will extend over the remainder of 2013.

Last week's post on the first-quarter GDP estimate contained a chart showing the quarterly change in “underlying” output, i.e. gross value added* excluding oil and gas production and adjusted for extra bank holidays and the Olympics. This quarterly change has risen from a low of -0.1% in the fourth quarter of 2011 to 0.0%, 0.1%, 0.2%, 0.2% and 0.3% in the first quarter of 2013. Far from “flatlining”, the economy has been gradually gaining momentum since late 2011.

The chart below shows the change in actual and underlying output over two rather than one quarters, comparing this with the six-month change in the real “Divisia”** money supply, including and excluding money holdings of financial institutions. Economic weakness in 2011 was foreshadowed by a contraction in the real money supply starting in mid 2010. The six-month change in real non-financial Divisia, however, turned positive in late 2011 and rose steadily during 2012, signalling an accelerating economic revival from mid 2012, allowing for the typical half-year lead of money to activity.

Six-month real Divisia growth has stabilised since late 2012 but at a level historically associated with solid output expansion. The message is that economic momentum will continue to build through late 2013 (at least). The view here remains that 2013 will be the best year for the economy since 2006.

*Gross value added = gross domestic product excluding indirect taxes and subsidies.
**The Divisia measure combines the components of the M4 broad money supply using liquidity weights based on interest rates.

Lofty global bond prices partly reflect expectations of a wave of Japanese buying prompted by Bank of Japan (BoJ) suppression of domestic yields. The Japanese, however, may never arrive.

Japanese investors remained net sellers of foreign bonds and notes in the week before last, as they have been in 11 of the last 12 weeks – see first chart.

The suggestion is that they are about to pile into overseas bonds to escape lower domestic yields and a weakening yen. The real trade-weighted yen, however, is near the bottom of its historical range, having fallen by more than 20% over the last 10 months – second chart. Risk-averse Japanese investors are unlikely to judge it a good time to raise their foreign currency exposure.

The yield pick-up for accepting such exposure, moreover, has declined. JGB yields of all maturities are higher now than at end-March, before the 4 April BoJ announcement of expanded QE. The five-year benchmark yield has climbed from 0.13% to 0.24%, delivering a 0.57% capital loss (i.e. four years of yield). With five-year yields falling in the US (and elsewhere), the US / Japanese spread is almost back to the low reached in summer 2012, in turn suggesting that dollar / yen has overshot – third chart.

Global bond markets are at risk from a liquidation of speculative long positions opened in anticipation of the arrival of “greater fool” Japanese buyers.

Eurozone monetary developments remain mixed, with broad money soft but narrow money strengthening. (Real) narrow money has historically been a much better leading indicator of the economy so this mix is judged here to be positive, cautioning against consensus gloom*. Sluggish broad money, moreover, increases the probability of further ECB easing.

Broad money M3 fell by 0.1% in March, causing six-month growth to slip from 1.5% to 1.4%, or 2.8% annualised. Narrow money M1, by contrast, rose by 0.5%, pushing six-month expansion up from 3.1% to 3.6% – 7.3% annualised.

A geographical split is available for M1 (i.e. overnight) deposits, which comprise 83% of the aggregate. Eurozone-wide real M1 deposits (i.e. deflated by consumer prices) climbed 3.3% in the six months to March, or 6.7% annualised. This is the largest six-month increase since February 2010, when the Eurozone economy was expanding solidly – see chart. (M3, incidentally, was contracting in early 2010.)

Crucially, real M1 deposits are now growing respectably in the periphery (i.e. Italy, Spain, Greece, Ireland and Portugal) – 2.7% in the latest six months versus 3.6% in the core. Periphery / core divergence warned of the “crises” of recent years but the gap is now the smallest since 2009. The six-month change was positive in all five peripheral economies in March.

The core / periphery distinction, indeed, is no longer helpful: the six-month change was stronger in March in Italy and Spain than in the Netherlands, Belgium and France – the latter still negative. German growth remains much the strongest of the major economies – 5.6%, or 11.5% annualised.

*Narrow money is held mainly for transactions purposes whereas broad money is dominated by savings deposits. Households / firms are likely to increase their transaction balances ahead of a rise in spending. Broad money can be unchanged or even fall, for example if there is a simultaneous shift of savings out of banks into markets, to the extent that this transfer is reflected in a contraction of banks’ balance sheets.

GDP grew by 0.3% (0.31% before rounding) between the fourth and first quarters versus an above-consensus estimate here of a 0.2% gain – see Friday’s post. As expected, the rise was driven by solid expansion in the dominant services sector (+0.6%), which offset weakness in construction (-2.5%), with little contribution from industrial production (+0.2%).

The 0.3% GDP increase probably understates economic performance because 1) construction output is likely to have been affected by poor weather and 2) the recent pattern has been for initial estimates of the GDP change to be revised up. GDP would have risen by 0.48% if construction output had been stable last quarter, as suggested by a modest recovery in new orders in late 2012. The quarterly GDP change, meanwhile, has been revised up by 0.15% on average since the start of 2009 (i.e. comparing the initial estimate with the latest data vintage). Taking both considerations into account, “true” growth may have been 0.5% or more.

Today’s news should, thankfully, put to rest silly “triple dip” commentary – silly because the fourth-quarter GDP decline was entirely attributable to a reversal of the Olympics boost in the third quarter so clearly did not signal underlying economic contraction.

The focus now is on how much longer the “double dip” of the fourth quarter of 2011 and first quarter of 2012* survives in the official data. The quarterly GDP changes in the two quarters have so far been revised from an initially-reported -0.3% and -0.2% respectively to -0.1% and -0.1%. As previously explained, the double dip has already disappeared in onshore GDP data (i.e. excluding North Sea oil and gas production).

GDP last quarter was still 2.6% below the peak reached in the first quarter of 2008 but the onshore shortfall is significantly smaller, at 1.7%. The latest onshore GDP index estimate, of 104.5*, is 0.4% below the annual maximum of 104.9 reached in 2007. Moderate further growth in the remaining quarters of 2013, in other words, would result in a new annual high this year.

The sectoral detail in today’s report highlights a continuing depression in the (tiny) agricultural sector – output fell by 3.7% last quarter to stand 14.2% below a peak reached in the second quarter of 2008. Upward pressure on food prices may persist.

*GDP also fell in the second quarter of 2012 but this was attributable to an additional bank holiday.
**Based on 2009 = 100.

Global bank reserves are monitored here as an indicator of central bank policy rather than because they have a significant direct implication for the economy. Reserves can sometimes signal policy shifts that are not associated with a change in official interest rates. This may be useful for anticipating market developments given the importance of policy for investor “risk appetite”.

As previously discussed, aggregate reserves held at the Fed, ECB and Bank of Japan fell to a 12-month low in early March as a repayment of LTRO borrowing by Eurozone banks offset US and Japanese QE. The ECB’s willingness to allow this liquidity drain was a signal of a neutral or even restrictive policy bias and was reflected in a firming of short-term market interest rates (e.g. the three-month EONIA swap). The fall in G3 reserves suggested that the ECB’s “stealth tightening” was more significant than continued US / Japanese easing. The shift away from aggregate accommodation may have contributed to risk assets losing momentum recently.

The G3 total, however, has rebounded strongly over the last month as the Eurozone LTRO repayment has slowed, US QE has continued and Japanese reserves have reconnected with their (now-steeper) expected path – see chart. Aggregate reserves are currently only 4% below the February 2012 high and are certain to move significantly above it over the remainder of the year – the illustrative projection* in the chart shows them climbing 22% by end-2013.

The projection may be conservative if the ECB, as widely expected, responds to recent soft economic news and a fall in inflation by launching further easing. A cut in the headline refinancing rate would not, in itself, expand reserves. The ECB could introduce a new facility allowing banks to borrow at a lower rate (0.25%?) against SME loans, echoing the Bank of England’s funding for lending scheme. Take-up, however, could be modest and drawn-out, judging from UK experience, implying no big impact on reserves.

Global growth may be peaking but significant weakness may be necessary to trigger a bearish market scenario, given ongoing liquidity support. The forecasting indicators monitored here, while moving lower, have yet to signal such weakness.

*The projection assumes that the Fed lowers securities purchases from $85 billion to $40 billion per month during the second half while the BoJ implements its recently-announced QE plan and Eurozone LTRO repayments taper to zero by mid-2013.

UK public sector net borrowing, excluding the temporary impact of financial interventions and the transfers of the Royal Mail pension scheme and the Bank of England’s QE income, was £120.6 billion in 2012-13 – marginally below the Office for Budget Responsibility forecast of £120.9 billion and an outturn of £120.9 billion in 2011-12. The Chancellor, therefore, has avoided the embarrassment of a rise in  “underlying” borrowing, although only because of a late-year effort to defer some spending into 2013-14.

Or has he? The above measure, on which media reporting appears to be focusing, still includes a one-off benefit from the transfer of profits of the Bank of England’s Special Liquidity Scheme (SLS) in April 2012. If SLS flows are also excluded, borrowing was £123.0 billion in 2012-13 versus £120.2 billion in the prior financial year.

Does anyone except the Chancellor and Ed Balls care? The “big picture” is that deficit reduction is proving painfully difficult but any feasible alternative strategy – whether involving more or less “austerity” – would probably make only a minor difference to the economic and fiscal outlook.