Japanese monetary trends continue to signal respectable economic performance but are less strong than in the Eurozone and US, despite record QE.

Narrow money M1 and broad money M3 rose by 0.3% and 0.2% respectively in March. Six-month growth rates eased to 2.6% for M1 and 1.6% for M3, or 5.3% and 3.2% annualised respectively – see first chart. For comparison, Eurozone M1 and M3 rose by 11.8% and 5.1% annualised in the six months to February, the latest available month.

M1 and M3 slowed in late 2013 / early 2014 – first chart. With inflation boosted by the April 2014 sales tax hike, real money contracted, correctly signalling economic weakness – second chart. Nominal money growth recovered during the second half of 2014 while six-month inflation has fallen back, reflecting both a reversal of the sales tax effect and weaker energy prices. Real money trends, therefore, are again consistent with respectable economic expansion.

The bigger story is that QE appears to have had little impact on monetary growth in recent years. The annual increase in M3 stood at 2.1% when the Bank of Japan (BoJ) launched QE in October 2010. It was 3.0% in March 2015. The BoJ is currently buying securities at an annual pace of ¥83 trillion, equivalent to 6.8% of M3. This suggests QE “pass-through” of 13% (i.e. 0.9 as a percentage of 6.8). An earlier analysis of UK QE arrived at a similar pass-through estimate of 21% – much lower than the Bank of England’s claimed 59%.

What explains the high “leakage”? An analysis of the monetary counterparts shows that the increase in BoJ lending to the government has been offset by a reduction in bank exposure. Banks have cut their lending because QE has boosted their reserves at the BoJ, meaning that they need to hold fewer government bonds to meet liquidity targets*. When QE started in October 2010, combined lending to the government by the BoJ and banks was contributing 3.3 percentage points (pp) to annual broad money growth, comprising 0.5 pp from the BoJ and 2.7 pp from banks** – third chart. On the latest figures, for January 2015, the combined contribution was 2.9 pp, with the BoJ adding 5.3 pp but banks subtracting 2.4 pp.

Near-term economic prospects may be improving but the BoJ deserves little credit.

*This response was predicted in a post in April 2013.
**Difference due to rounding.

A post in February suggested that global growth would pull back into mid-2015 before strengthening significantly in the second half of the year. This scenario remains on track judging from monetary trends and leading indicators.

Global growth is proxied here by the six-month rate of change of industrial output in the G7 and seven large emerging economies*. This rebounded between August and December 2014, stabilising in early 2015 – see first chart.

The OECD today released February data for its country leading indicators, allowing an update of the global longer leading growth measure followed here. This had been stable at a respectable level through January but fell back in February, consistent with a near-term loss of economic momentum**.

Monetary trends suggest that this pull-back will be modest and temporary. The real or inflation-adjusted money supply leads activity by six to 12 months, according to the monetarist rule. Global six-month real narrow money growth fell between March and August 2014, signalling slower economic momentum in early 2015. The decline was due to the US, where economic news has been surprising negatively, as forecast in a post in September.

Global real money expansion, however, rebounded strongly in late 2014, reaching a 38-month high in February. The global economy, therefore, should regain speed this summer and is likely to be growing at a rapid pace by late 2015. Again, the momentum change should be driven by the US, reflecting recent better monetary trends.

Second-half economic strength should be accompanied by a rebound in inflation, posing a risk to government bond markets. The six-month change in global consumer prices should stage a V-shaped recovery if oil and other commodity prices stabilise at current levels – second chart. This would probably pull down real money growth, in turn suggesting another economic slowdown in 2016. A fall in the gap between real money growth and output expansion, meanwhile, could imply less favourable liquidity conditions for equities later in 2015.

*Industrial output is preferred to GDP because it is more timely, less revised, available monthly and better correlated with equity market earnings.
**The February decline may have been exaggerated by the impact of bad weather and a ports strike in the US, and a late new year holiday in China.