A measure of the rental yield on residential property derived from the national accounts rose further above its long-run average in the first quarter of 2013, suggesting that house prices are becoming increasingly undervalued relative to rents.

The national accounts yield measure is calculated by dividing the sum of actual rental payments and imputed rents of owner-occupiers by the value of the housing stock. The yield is calculated on a trailing 12-month basis, i.e. its first-quarter value equals rents in the year to end-March divided by the end-March value of the housing stock.

The rental yield has averaged 4.26%* since 1965, moving well below this level during the house price bubbles of the early 1970s, late 1980s and 2000s associated with monetary laxity overseen respectively by Lords Barber, Lawson and King.

The yield reached a low of 3.34% in the third quarter of 2007, suggesting that house prices were then overvalued by 28% relative to rents (i.e. the percentage deviation of 4.26 from 3.34). It has since risen steadily, reflecting a fall in prices in 2008-09 and sustained solid growth in rents.

The yield was an estimated** 4.89% at the end of the first quarter, consistent with house price undervaluation of 13%.

Houses remain expensive in terms of earnings but bubbles are characterised additionally by an overshoot of prices relative to rents, as rose-tinted perceptions of capital gains potential distort assessments of the merits of owning rather than renting. Government policies designed to stimulate home-buying are ill-advised but current prices are far from bubble territory.

*The yield series has shifted higher as a result of a recent change in national accounts methodology; specifically, imputed rents are now measured on a gross basis before subtracting estimated repairs and maintenance costs.
**The value of the housing stock at end-March was estimated by linking a published end-December reading to the change in the official house price index between December and March.

UK real money growth has stabilised at a level suggesting solid second-half economic expansion.

The favoured broad and narrow aggregates here are non-financial M4 and M1, comprising holdings of households and private non-financial firms. These measures rose by 2.6% and 5.7% respectively in the six months to June, or 5.2% and 11.7% annualised. This represents significant real expansion since consumer prices rose by 1.0% after seasonal adjustment, or 2.1% annualised, over the same period – see first chart.

Following real contraction in 2011, non-financial M4 and M1 growth crossed above inflation at the start of 2012, signalling an economic recovery from mid-2012, allowing for the usual half-year lead.

Broad money growth remains modest by pre-crisis standards but is unlikely to be “too low” because the demand to hold money is being depressed by negative real deposit interest rates. It is the difference between the supply of money and the demand to hold it that determines whether economic activity / inflation will rise or fall.

Put differently, the MPC would guarantee an inflation overshoot if it were to commit to maintaining rock-bottom official rates until broad money expansion rose to an historically-normal rate of 7-8%*.

Much faster expansion of M1 than M4 is viewed here as evidence that households and firms are deploying monetary savings in the economy – funds have been moved from savings to current accounts to finance higher spending and financial investment. Such a shift has been encouraged by a further collapse in savings deposit rates over the last year, partly due to the funding for lending scheme. The M1 / M4 divergence, in other words, suggests a rise in the velocity of circulation.

Despite the suspension of formal QE last November, non-financial M4 rose at similar rates in the first half of 2013 and second half of 2012, i.e. 5.2% annualised versus 5.9%. This is consistent with the view here that QE had only a small positive impact on monetary growth. Broad money trends have been supported recently by a reduction in banks’ wholesale funding (i.e. net external and foreign currency borrowing and sterling non-deposit liabilities). For a given stock of sterling bank lending to the UK private and public sectors, a cut in such funding leads to a rise in M4.

Private-sector lending fell slightly in June but may expand in the second half – credit is usually a coincident or slightly lagging indicator of the economy. Arranged but unused sterling credit facilities rose by 4.4%, or 9.0% annualised, during the first half – second chart.

*Non-financial M4 grew at an average annual rate of 7.7% in the 10 years to December 2007.

Echoing trends elsewhere, Eurozone June money supply numbers were disappointing, with the narrow M1 and broad M3 measures falling by 0.6% and 0.4% respectively from May. Earlier M1 strength suggests a respectable economic recovery during the second half but this could fade at year-end if June monetary weakness extends into the current quarter.

Six-month growth of real M1 remains solid by historical standards but has slipped back to its lowest since February.


M1 comprises physical cash and overnight deposits; a country breakdown is available for the latter. Lower six-month growth in real deposits in June reflected falls in both the core and periphery.


Real deposit growth declined in all four major economies in June while remaining consistent with economic expansion. Dispersion across the four is low by the standards of recent years, suggesting less economic “divergence”.

UK GDP rose by 0.6% in the second quarter (0.62% before rounding), in line with an upwardly-revised consensus forecast but below a long-standing 0.8-0.9% projection here.

As suggested in a post on Monday, services contributed more (0.48 percentage points) to quarterly growth than forecast by the consensus – the index of services rose by 0.2% in May after an upwardly-revised 0.3% April gain. This positive surprise, however, was offset by a weaker-than-expected contribution from construction: output grew by only 0.9% last quarter, adding 0.05 of a percentage point to GDP growth versus a forecast here of up to 0.2.

The construction figure, of course, is highly provisional and could well be revised up to show greater consistency with stronger orders and survey data. An official assumption that services output fell back by 0.1% in June is also questionable – the purchasing managers’ services activity index reached a 27-month high last month. The view here is that second-quarter growth will be upgraded by at least 0.1 percentage point as the revisions process unfolds over the remainder of 2013.

The “big picture” confirmed by today’s news is that an economic revival dating back to mid-2012 gathered pace last quarter. The improving trend is illustrated by the red bars in the chart, showing quarterly growth adjusted to exclude changes in North Sea oil and gas extraction and the effects of additional bank holidays and the Olympics. This underlying measure rose from zero in the second quarter of 2012 to 0.1% in the third quarter, then 0.2%, 0.2% and 0.6% last quarter.

Note that this pick-up pre-dated both the funding for lending scheme, which gained traction only in late 2012, and sterling weakness in early 2013 – factors cited by a respected commentator on BBC Radio Four’s Today programme this morning as key drivers of economic improvement. The view here, by contrast, is that the revival in activity from mid-2012 reflected a resumption of real (i.e. inflation-adjusted) money supply expansion from late 2011 – monetary trends lead the economy by about six months, according to the “monetarist” rule.

The real money turnaround since 2011 has been due to a combination of financial recuperation, a fall in inflation and – possibly – policy initiatives in the form of QE and FLS. As explained in a previous post, QE may have boosted the broad money supply by much less than claimed by the Bank of England, since official gilt-buying probably “crowded out” purchases by commercial banks, which have similar monetary effects.

Real money growth, on both broad and narrow measures, has remained healthy through May (June numbers will be released on 29 July), suggesting solid second-half economic performance.

Contrary to some expectations, nominal broad money trends have not slowed significantly since formal QE was suspended in late 2012, while narrow money has accelerated further. Credit leading indicators, meanwhile, have improved, suggesting that lending expansion will support monetary growth during the second half. There is, in other words, no case for additional monetary stimulus currently; such stimulus, indeed, could be counterproductive to the extent that it leaks into prices and causes a larger inflation drag on real money expansion.

Recent data confirm the monetarist forecast here of a recovery during 2013 in Eurozone economic activity, with improvement extending to peripheral countries in the second half.

Note, first, that Eurozone industrial output rose by 1.5% (not annualised) in the six months to May – the strongest six-month change since March 2011. The return to growth was predicted by a pick-up in real narrow money M1 during 2012.


Purchasing managers’ surveys have been improving gradually and the manufacturing / services composite output index finally broke above 50 in July, according to “flash” results released today. Historically, Eurozone GDP has grown with the index slightly below 50, so forthcoming figures could show expansion even in the second quarter. Manufacturing-only survey data confirm the pick-up in industrial activity, with orders at a 26-month high.


The positive message from monetary trends was reinforced by an easing of credit conditions in the first-quarter ECB bank lending survey, released in April, showing net percentages of banks tightening credit standards on loans to firms falling to levels historically consistent with economic expansion. Today’s second-quarter survey reports further improvement, particularly in expectations (the credit tightening balances are plotted inverted below).


“Good” news in the periphery includes a further recovery in July in PMI composite output and employment indices for the Eurozone ex. Germany / France, as well as the Bank of Spain’s estimate this week that GDP contracted by only 0.1% in the second quarter.

June monetary data released tomorrow will be important for assessing whether current promising trends will extend into 2014. 

The UK labour market is strengthening rapidly, a trend that could undermine the impact of any new MPC commitment to maintain current policy until the unemployment rate falls to a given level.

The MPC is widely expected to specify one or more “intermediate thresholds” for policy tightening next month in an effort to anchor the short end of the yield curve and bolster consumer and business confidence. A threshold based on the unemployment rate would have the advantage of simplicity and would mirror the approach of the Federal Reserve, which has committed to maintaining current official rates at least until the unemployment rate falls to 6.5%, providing that inflation and inflation expectations remain contained.

The Fed has set its threshold 2.1 percentage points above the jobless rate low of 4.4% reached in 2006-07, judging this margin sufficient to exclude the possibility of unemployment falling to an inflationary level (i.e. to below the “NAIRU”, or non-accelerating-inflation rate of unemployment). The UK unemployment rate troughed at 4.7% in 2004-05 so an equivalent approach would involve setting the threshold at 6.8%, or 6.75% rounding to the nearest 0.25 percentage point.

The unemployment rate was 7.8% over March-May, or 7.77% before rounding. As explained below, it is likely to fall significantly over the remainder of 2013 and, if the trend is sustained, could reach 6.75% in mid-2014. Since markets do not currently expect an official rate rise until 2015, this suggests that a threshold set at 6.75% would have no beneficial impact and could even prove counterproductive, by sharpening investor focus on better-than-forecast labour market outcomes.

The arithmetic of this scenario is as follows. Vacancies lead employee numbers and rose by 7% over March-May from six months earlier. Historically, such an increase has been consistent with employee growth of about 1% over six months, or 2% annualised – see first chart. A 2% rate of expansion would create 590,000 additional employees by mid-2014 (i.e. over the 14 months from March-May 2013 to May-July 2014).

Total employment would probably rise by slightly less because some of the additional employees would be drawn from the currently self-employed. Suppose that total employment increases by 550,000 by mid-2014.

Unemployment also reflects expansion of the labour force (i.e. those in or actively seeking work). Labour force growth has averaged 0.6% over the last 40 years. This rate of increase would result in a 230,000 rise by mid-2014. Combined with a 550,000 increase in employment, this would imply a fall in unemployment from 2.505 million currently to 2.185 million, or 6.7% of the labour force.

Unemployment pessimists argue that any decline will be slowed by a return of “economically inactive” people to the labour force. At 22.5%, however, the inactivity rate is currently low by historical standards – second chart. The rise in inactivity in 2009-10 was surprisingly small compared with previous recessions and has been more than reversed subsequently. A further consideration is that working-age population growth has slowed – to only 0.1% in the year to March-May. Assumed labour force expansion of 0.6% annualised, therefore, seems reasonable.

The plausibility of the above scenario is supported by the latest data for the more timely claimant-count unemployment measure – jobless claims dropped 21,000 in June, close to the 23,000 average monthly decline needed for labour force survey unemployment to fall to 2.185 million by mid-2014.