Chinese equities reacted negatively to news that annual growth in the M2 money supply fell to 12.1% in March – below the 13% official target for 2014 and the lowest on record in data extending back to 1998. The forecasting approach here emphasises the six-month change in inflation-adjusted M2*. This measure edged lower in March but is in line with its average over 2011-13 and above readings between September and November last year – see first chart.

Six-month real M2 growth has been supported by a recent fall in inflation: consumer prices* rose by an annualised 1.4% in the six months to March, down from 3.3% in the previous half-year.

Six-month expansion of the narrower M1 measure, inflation-adjusted, rose slightly in March, though remains weak by historical standards. Real bank lending and the broader “total social financing” credit aggregate, meanwhile, are growing respectably – second chart.

Slower industrial output growth since late 2013 was foreshadowed by a fall in real M2 / M1 expansion from spring 2013. The partial reversal of this decline recently suggest that industrial momentum will bottom during the second quarter, recovering slightly over the summer. Monetary trends, in other words, are not signalling a “hard landing”, although growth will remain below par by the standards of recent years.

*Seasonally adjusted.

The MSCI Japan index fell by 9.1% in US dollar terms between end-2013 and yesterday, while the All-Countries World index was unchanged (-0.1%). Japanese stocks have been underperforming since July, when real narrow money growth started to diverge negatively from global trends. Based on March monetary data released today, Japanese real narrow money* is estimated to have risen by 1.3%, or 2.7% annualised, over the last six months. This compares with a six-month gain of 3.8%, or 7.8% annualised, in the global aggregate monitored here in February (the latest available month).

Why has real narrow money growth remained weak despite the Bank of Japan’s QE blitz? There are three reasons. First, QE has had a disappointing impact on the broad money supply. Annual M3 growth has risen from 2.5% in March 2013, just before the QE expansion, to 2.9% last month. As suggested in a post a year ago, the BoJ’s bond purchases have been significantly offset by selling by banks, whose demand for liquid securities has fallen as QE has expanded their reserves. Over 2013 as a whole, the BoJ bought ¥67 trillion of public sector securities, while depository corporations sold ¥32 trillion, according to the flow of funds accounts – see first chart. Total banking system purchases, therefore, were ¥35 trillion – in the middle of the range of recent years and equivalent to a modest 3.1% of M3.

Secondly, the minor uplift to nominal money growth from expanded QE has been outweighed by a pick-up in inflation, driven mainly by yen weakness that was a subsidiary aim of the policy. Real money expansion on both broad and narrow measures is now significantly lower than was achieved in 2012 / early 2013 under the previous BoJ leadership, which pursued less aggressive QE but did not promote yen depreciation – second chart. Inflation will be mechanically boosted by the recent sales tax increase but the yen impact is fading.

Thirdly, narrow money trends are largely demand-driven, reflecting the needs of consumers and firms to hold immediately-available liquidity for use in future economic and financial transactions. Even if QE were to succeed in delivering a large boost to broad money, there is no guarantee that this increase would feed through to a higher level of transactions, as opposed to being “hoarded”. The failure of narrow money to surge suggests that “Abenomics” has yet to have the desired stimulatory impact on consumer / business behaviour.

On current monetary readings, Japanese economic growth is likely to remain lacklustre, while equities hold little relative attraction. The hope is that real money trends will improve later in 2014 as bank lending continues to strengthen, inflation subsides as the yen / tax boost fades and consumer / business confidence rebounds, possibly in conjunction with a stronger global economy. Such a scenario could be disrupted if current disappointing news prompts further BoJ fireworks and another inflation-boosting fall in the exchange rate.

*M1 deflated by consumer prices, seasonally adjusted. March CPI estimated from Tokyo data.

Global* short- and longer-term leading indicators** support the forecast here that six-month industrial output growth will pick up from a trough to be reached in the late spring.

The two indicators have led growth turning points by 2-3 months and 4-5 months respectively in recent years. The longer-term measure peaked in July-August 2013 while the short indicator topped in August-September. Global six-month industrial output growth reached a maximum in November-December, falling again in February, based on data covering 75% of the aggregate monitored here – see first chart.

The longer-term indicator, however, recovered in February while the short measure stabilised. This suggests that output growth will decline further to a trough in May before rebounding into the summer.

The rise in the longer-term leading indicator confirms an earlier positive signal from global real narrow money expansion, which bottomed in November 2013 and has picked up strongly in early 2014 – second chart and previous post. The summer growth rebound, in other words, is likely to be significant and sustained into late 2014.

*”Global” = G7 developed economies and E7 emerging economies.
**The indicators are calculated by transforming and combining the OECD’s country leading indices. The message from these derived indicators often disagrees with the OECD’s interpretation of its own data.

The first-quarter British Chambers of Commerce survey supports the assessment here that recent strong growth has exhausted spare capacity and is starting to put upward pressure on inflation, implying a significant probability that the Bank of England will be forced to raise official rates before year-end.

The percentage of services firms operating at full capacity rose further last quarter, to the second highest level in the survey’s 25-year history – see first chart. The manufacturing percentage fell slightly but is also near the top of its historical range.

The percentage of services firms planning to raise prices rose for a third quarter to its highest since the first quarter of 2011 – second chart. The manufacturing percentage declined, probably reflecting recent sterling strength, but remains above average.

In other news today, industrial output rose by a stronger-than-expected 0.9% in February, further increasing the probability that the preliminary estimate of first-quarter GDP growth released later this month will exceed the Bank of England’s 0.8% assumption in the February Inflation Report – see previous post.

The ECB is under fire for keeping policy stable despite supposed deflationary dangers. Posts here were highly critical of the central bank in 2011, when it tightened policy in the face of real money supply contraction, thereby guaranteeing a recession. Its stance, however, reversed dramatically under President Draghi, resulting in the current economic recovery. While policy should be kept under review, the ECB’s passivity is justified.

• The recent further fall in CPI inflation to 0.5% in March reflects weaker food and energy prices, which may prove temporary and, in any case, are positive for real incomes. The March result was also depressed by Easter timing effects (i.e. an Easter boost lifted prices in March 2013 but will occur in April this year*).

• Core inflation and wage growth stabilised in late 2013, consistent with a stabilisation and improvement in monetary trends from late 2011 – monetary developments lead price and wage pressures by about two years, according to the Friedmanite rule. This rule suggests that domestic inflation will gradually revive in 2014-15 – see chart.

• Current monetary trends are satisfactory. Annual narrow money M1 growth of 6.2% is slightly below the EMU-era average in nominal terms (7.5%) but equal after inflation adjustment. M3 growth remains weak at only 1.3% but M3 velocity is rising in response to falls in deposit interest rates. The monetary impact of credit contraction is being offset by a strong balance of payments surplus.

• Exchange rate strength is unwelcome but reflects policy laxity elsewhere and may reverse if the US economy picks up speed this summer, as suggested by narrow money buoyancy. It is doubtful that the trend would be affected by a small cut in interest rates.

• As previously discussed, there is little evidence that QE programmes in the US, UK and Japan have boosted economic performance or even monetary growth significantly. In Japan’s case, real money expansion is lower than when its QE blitz was launched in April 2013; it is lower, indeed, than in the Eurozone currently. QE has succeeded in driving the yen down but to little effect – the export volume response has been pitiful, as it was in the UK after sterling’s 2007-08 crash.

With monetary trends stable, market interest rates falling, surveys signalling an ongoing economic recovery and global prospects probably brightening, the ECB’s inertia is warranted. Policy-makers are rightly allowing for the lag in the money / inflation relationship; reacting to the latest CPI data would be destabilising. They should retain an easing bias but act only if narrow money growth falters.

*Accordingly, April CPI inflation may overstate the underlying trend.

UK households’ net housing and financial wealth (i.e. the value of housing and financial assets minus financial liabilities) rose by an estimated* 8.3% during 2013, pushing its ratio to annual disposable income up to 7.14 – close to a record high of 7.4 reached at end-2007.

The first chart shows the net wealth to income ratio broken down into housing, financial assets and financial liabilities. The recovery in the ratio since 2008 has been driven by rising financial wealth and a reduction in liabilities. The housing wealth to income ratio has been broadly stable over this period, though increased in 2013 as house prices picked up.

The rise in net financial wealth mainly reflects gains in equity and bond markets but, in addition, households ran a large financial surplus over 2009-12, cumulating to 8.9% of annual income over the four years (i.e. income exceeded consumption and capital spending over this period, allowing households to accumulate financial assets and / or reduce debt).

The net wealth to income ratio is likely to reach a new record by end-2014, assuming house price inflation of about 10% during the course of the year and stable financial markets.

Rising wealth helps to explain why consumer confidence is at the top of its historical range despite the “cost of living crisis” – second chart. It also tempers concern about a recent fall in the saving ratio, which, in any case, remains respectable – 5.0% in the fourth quarter of 2013, close to a 20-year average of 5.5%.

*Based on actual data on financial assets / liabilities and income, and an assumption that the value of the housing stock rose by 5.5% during 2013, equal to the increase in the ONS house price index between December 2012 and December 2013.