Today’s public sector finances numbers for January – a key month for tax receipts because of self assessment returns and quarterly corporation tax payments – cast further doubt on the upward revisions to borrowing forecasts by the Office for Budget Responsibility (OBR) in its November 2011 Economic and Fiscal Outlook.

With the January number better than expected and borrowing in earlier months of 2011-12 revised down, the targeted PSNB ex measure (i.e. public sector net borrowing “excluding the temporary effects of financial interventions”) was £15.7 billion lower over April to January than in the corresponding period of 2010-11. PSNB ex is on course to total about £119 billion in 2011-12 compared with an OBR forecast of £127 billion – wrongly revised up in November from £122 billion despite satisfactory year-to-date developments.

The suggested £119 billion outcome, indeed, is close to the OBR’s £116 billion forecast for 2011-12 made at the time of Chancellor Osborne’s first Budget in June 2010. It would equate to 7.8% of GDP compared with peak borrowing of 11.1% of GDP in 2009-10.

A bigger story that may go unreported, however, is the faster decline in the “old” PSNB measure that includes the surplus of the public sector banks and net interest income of the Bank of England’s Asset Purchase Facility (APF). PSNB is on course to fall from £109 billion last year to about £85 billion – £16 billion lower than the OBR’s November forecast and equivalent to “only” 5.6% of GDP.

QE income accounts for about £9 billion of the estimated £34 billion difference between PSNB and PSNB ex in 2011-12 and should rise further to about £11 billion in 2012-13, based on announced plans to expand the APF and assuming no change in Bank rate. (A previous post argued that the Treasury should “book” this income by requiring the APF to pay an annual dividend. Such a treatment would be equivalent to that adopted in the US, where the profit of the Federal Reserve, including its net income from QE, is distributed to the Treasury. The Fed has estimated that the distribution relating to 2011 will be $76.9 billion, up from $31.7 billion in 2008, with the increase mainly reflecting the expansion of its balance sheet due to asset purchases.)

PSNB includes the entire surplus of the public sector banks and their subsidiaries – an estimated £25 billion in 2011-12 – but the government’s economic ownership of Royal Bank of Scotland and Lloyds Banking Group is 83% and 41% respectively. (It also owns the mortgage books of Northern Rock and Bradford & Bingley.) Only about 60% of the banks’ surplus, therefore, should be attributed to the public sector. Such a treatment suggests “true” net borrowing of about £95 billion in 2011-12, or 6.2% of GDP. (The attributable surplus, of course, is not available to finance immediate government spending. With no dividends being paid, however, the surplus results in a rise in the book value of the government’s shares, an increase that should be reflected in the proceeds of the banks’ eventual sale.)

A post last week argued that the current mini-upswing in global growth would peak this spring, based on a slowdown in real narrow money since late 2011. Such a scenario should be flagged by a topping out of widely-watched manufacturing purchasing managers’ survey indices – the forward-looking new orders component in particular.

A peak in the US ISM manufacturing new orders index within the next couple of months is suggested by recent falls in three-month retail sales volume growth and the expected orders balance in the Philadelphia Fed regional manufacturing survey. Both measures tend to lead ISM new orders, as the following charts show.

The prospect of less upbeat global economic news from the spring may warrant investors trimming overweight positions in equities and other risk assets. It may, however, be premature to move underweight, for several reasons.

First, equities have tended, if anything, to lag the economic cycle in recent years. The March 2009 US stock market low, for example, followed a December 2008 bottom in ISM manufacturing new orders. The July / August 2011 sell-off, similarly, occurred after a May plunge in the ISM. On this basis, a March 2012 peak in new orders could be consistent with equities remaining firm until May / June.

Secondly, while investors have embraced risk recently, available evidence does not suggest that positions are extreme. Fund manager cash levels are normal rather than low, according to the February Merrill Lynch survey. The Credit Suisse risk appetite measure, similarly, is far below the “euphoria” region that often marks cycle tops.

Thirdly, global liquidity conditions remain favourable, with G7 real narrow money outpacing industrial output and central banks continuing to inject liquidity – the second ECB three-year LTRO coupled with stepped-up JGB purchases by the Bank of Japan may lift G7 bank reserves above their late 2011 high. The mid-2011 economic cycle peak, by contrast, occurred when the G7 real narrow money / industrial output growth gap was negative and US QE2 was ending, possibly explaining the severity of the subsequent risk sell-off.

Finally, markets may “look through” a modest weakening of economic indicators on the view that this would give a trigger-happy Fed an excuse to launch QE3. True, US “core” inflation is proving uncomfortably resilient – see below – but modern central bankers routinely ride roughshod over facts in pursuit of ideologically-driven policy prescriptions, as recent UK experience amply demonstrates.

Does anyone seriously believe that the French economy expanded by 0.2% last quarter while the UK contracted by the same percentage, as claimed by the respective national statistics bodies?

Business surveys suggest the opposite experience: the average level of the PMI composite output index was above the breakeven 50 level in the UK last quarter but below it in France.

The guess here is that the GDP discrepancy is due to French statisticians, but not their UK counterparts, applying a working-day adjustment to the raw numbers. There were 63 working days in the UK last quarter, one fewer than in the prior four years, according to www.work-day.co.uk. The Office for National Statistics adjusts GDP data for seasonal factors but not working days.

Working-day adjustments applied by the French and other continental European national statistics bodies are not proportional but are derived from regression models. One cannot, in other words, estimate workday-adjusted growth for the UK last quarter by adding back 1 as a percentage of 63, or 1.6% – the actual effect will have been much smaller. It is likely, however, that a properly-calculated correction would wipe out the reported 0.2% GDP decline.

If this explanation is correct, first-quarter GDP figures will flatter the UK relative to France as the workday effect reverses.

The current mini-upswing in global growth may top out in the spring. The extent of any subsequent slowdown will depend importantly on whether recent ECB policy easing succeeds in reviving Eurozone monetary expansion.

The first chart below shows six-month growth in global industrial output (i.e. a composite of the G7 and seven large emerging economies) together with the two key forecasting measures employed here – six-month real narrow money expansion and a leading indicator derived from the OECD’s country leading indices. The indicator signals turning points in output momentum about three months in advance while real money typically moves three months earlier (i.e. six months before output).
 
Faster real money growth from mid 2011 predicted recent economic acceleration, a forecast that was confirmed by an upturn in the leading indicator later last year. The indicator continued its pick-up in December (data released earlier this week), consistent with six-month output growth rising at least through March.

Six-month real narrow money expansion, however, appears to have peaked in November, falling back sharply in January, based on partial information. Allowing for the usual six-month lead, this suggests that output growth will top in May, a scenario that would be confirmed by the leading indicator peaking around February.

The second chart shows that the estimated January fall in global real money expansion mainly reflected weakness in China, where the reading was depressed by the early New Year holiday and should bounce back in February. US strength, however, has started to wane, possibly reflecting QE2 stimulus fading – “operation twist” has weaker monetary effects. Sustaining solid global real money growth, therefore, may depend on the ECB's interest rate cuts and liquidity injections reversing recent Eurozone weakness – January monetary figures will be released on 27 February.

The working hypothesis here – subject to revision in light of new monetary data – is that the ECB’s actions will prove at least partially effective and that global real narrow money will continue to expand at a respectable pace, consistent with a modest downshift in economic momentum from the spring rather than anything worse.

Today’s Inflation Report release and press conference followed the usual ritual, with the Bank listing all the reasons it does not know where growth and inflation are heading but signalling that it remains biased towards more easing anyway.

The policy signal in each Inflation Report is contained in a single statistic – the mean forecast for inflation in two years’ time assuming unchanged policy. This was 1.29% in November and seems to be 1.8% in the latest Report, based on eyeballing chart 5.13. (The Bank’s policy of delaying publication of its forecast numbers until a week after the Report is designed, presumably, to embarrass economists with inferior visual skills.) The message is that the Bank thinks that further easing will be required to hit the 2% target but is less dovish than a quarter ago – hardly a surprise.

The most interesting analysis in the Report is a box on pages 34 and 35 presenting evidence that consumer-facing companies’ profit margins remain far below their pre-recession level. The Bank’s forecast that the 12-month CPI increase will fall below 2% rests on a reduction in domestically-generated inflation as a pick-up in productivity growth puts downward pressure on unit labour costs. Firms, however, are more likely to use any slowdown in unit costs to rebuild margins, resulting in “core” inflation – stable above 2% in recent months – remaining elevated.

In a discussion on page 11 of the reasons for the weakness of broad money in the fourth quarter, the Bank seems to acknowledge that it has overpaid for gilts because of market players front-running its purchases, stating that “some financial institutions in the non-bank private sector may have borrowed money from banks to buy gilts in Q3 in anticipation of further asset purchases being announced by the MPC. That would have boosted money growth in Q3 and reduced it in Q4 when the gilts were sold and the loans were repaid.” Cue more populist headlines about QE fuelling City bonuses?

Labour market statistics released today were slightly better than expected, showing employment recovering and unemployment stabilising. Resilience had been suggested by recent strength in online job postings, as measured by the Monster employment index – see previous post.

The Labour Force Survey (LFS) employees measure – a three-month moving average – bottomed in October, rising 86,000 by December. This increase mainly reflects part-time jobs and the measure remains 79,000 below its level a year earlier. The Monster index, however, suggests further gains in early 2012 – see first chart.

LFS unemployment edged down by 14,000 in December though was up by 49,000 from September (three-month averages again). The LFS measure lags the claimant-count, which is still edging higher, implying that employment growth remains insufficient to offset labour force expansion – second chart.

The official vacancies series moved up further in January (three-month average), confirming the message from the more timely and leading Monster index. This reflects private sector strength, with vacancies outside public administration, education and health at a post-recession high – third chart.

The labour market remains weak but these statistics are not consistent with a “double dip”.