UK GDP is still expected here to have risen by 0.8-0.9% in the second quarter versus an upwardly-revised consensus forecast of 0.6%.

The hard data in hand are April / May output for the industrial and construction sectors, accounting for 14% and 6% of GDP respectively, and an April reading for services, with a 79% weighting. If it is assumed that output in the three sectors is unchanged at its latest published level, and there are no revisions to earlier data, GDP would rise by 0.5%. The consensus estimate, in other words, assumes little further growth later in the second quarter.

The expectation here, however, is that services output, in particular, will have registered further solid expansion. Supportive evidence includes:

• Retail sales volume in May / June was up 2.2% from April. Retail trade has a 7% weighting in the index of services, implying a 0.15% boost to output relative to April.

• Turnover in private non-financial services excluding retail / wholesale trade surged by 9.3% in value terms in May from a year earlier. This series is ignored by the consensus but is an important input to services output; the strength of the year-on-year gain suggests a significant positive contribution to the output change between April and May.

• Business surveys of services have been uniformly optimistic; the purchasing managers’ activity index, for example, reached a 27-month high in June.

A rise of 0.5% in services output in May / June compared with April is realistic on the basis of this evidence and would be consistent with a quarterly GDP rise of 0.8% (i.e. maintaining the other assumptions above).

Monetary trends and leading indicators have signalled respectable global growth through late 2013 – see previous post. The measure of global real money supply expansion tracked here, however, slowed significantly in June, based on data for countries with a weighting of about 60% in the aggregate. Allowing for the usual half-year lead, this suggests that economic momentum will fade at end-2013.

Specifically, six-month growth in real narrow money in the G7 and emerging E7 economies fell from 3.8% (not annualised) in May to an estimated 3.1% in June, which, if confirmed, would be the slowest since July 2012 – see first chart. (Narrow money is more closely related to economic transactions than broad money, which contains a significant savings element; this is confirmed by its superior leading indicator properties.)

The second chart decomposes real money growth into nominal monetary expansion and inflation. A rebound in inflation contributed significantly to the June real money slowdown, although nominal growth also eased.

The inflation drag on real money may intensify. The third chart compares changes in consumer and commodity prices. Commodities have driven the major fluctuations in inflation in recent years. Inflation undershot the relationship in early 2013, giving a temporary lift to real money expansion, but has since reconverged with the “predicted” level. Unless commodity prices show renewed weakness, the suggestion is that inflation will increase further.

The fourth chart shows real money growth for countries that have released June data. The fall in the global measure is mainly due to similar declines in the US and China. Chinese weakness may partly reflect last month’s short-lived money market squeeze; July figures will be awaited before concluding that monetary trends have deteriorated. The final June global reading will depend importantly on Eurozone data scheduled for release on Thursday.

The judgement here is that the monetary information in hand is insufficient to warrant turning more cautious on economic and market prospects. Even with the June decline, real money growth remains comfortably above industrial output expansion, suggesting “excess” liquidity that may support asset prices – see first chart. Relatedly, global fund manager cash balances are elevated, according to the latest Merrill Lynch survey; high cash is usually a signal of near-term market strength rather than weakness.
 

The preliminary GDP estimate for the second quarter is released on 25 July. The current state of knowledge is as follows.

• Industrial output, accounting for 14% of gross value added, was 0.2% above its first-quarter level in April / May. Assuming no change between May and June, the sector will add 0.03% to second-quarter GDP.

• Services output, with a weight of 79%, was 0.4% above its first-quarter level in April. Retail trade accounts for 7% of services output and sales volume increased by 2.1% between April and May, implying a boost of 0.15%. The purchasing managers’ services activity index rose solidly in both May and June, with similar strength recorded in other surveys. Based on these considerations, services output may have grown by 0.6-0.7% in the second quarter, implying a GDP contribution of +0.48-0.56%. Private services turnover for May released on 19 July will provide further information.

• Not-seasonally-adjusted construction output was 1.1% lower in April than a year before. Applying this change to the April 2012 reading of a provisional seasonally-adjusted series released by the Office for National Statistics in May suggests that April 2013 output was 3.4% above the first-quarter level. Assuming unchanged output in May and June, this would imply a GDP contribution of +0.19%, given the sector’s 6% weight. May seasonally-adjusted output together with a revised history will be released on 12 July and could significantly change this estimate.

The bottom line is that the data are tracking slightly below the forecast here of a 0.8-0.9% second-quarter GDP increase although the construction impact, in particular, is uncertain. The chart shows quarterly GDP levels together with a monthly estimate based on services, industrial and construction output data – the current April estimate is 0.55% above the first-quarter level.

The rise in longer-term bond yields in recent months is judged here to reflect a combination of improving investor expectations for second-half economic performance and growing scepticism of the ability of central banks to suppress yields below their “equilibrium” level. The alternative explanation that the increase has been driven by a shift in Federal Reserve policy is implausible – the economic implications of the Fed “tapering” in September rather than December are trivial.

With their ability to control longer-term rates in doubt, central bankers have turned to “forward guidance” to try to anchor the short end of yield curves. Last week’s dovish policy statements from the ECB and Bank of England were an attempt to reverse a May / June rise in market expectations of interest rates over the next two years – see chart*. This effort has been only partially successful – expectations have unwound about half of their earlier rise.

So is forward guidance, like QE, losing traction? The problem is partly that ECB / BoE guidance is “weak form”, stating that the central banks expect, on the basis of their current economic forecasts, to maintain low rates for longer than implied by the market. Such statements, however, have little value given the central banks’ proven inability to forecast.

Markets, therefore, may push shorter-term yields higher again in an effort to secure a Fed-style commitment to maintain current rates even if growth / inflation significantly exceed current projections. Such a commitment, however, is likely to be a step too far for the Bundesbank and its allies, and several – possibly a majority of – UK MPC members.

The central bankers have made exaggerated claims about their ability to manipulate yield curves to deliver further monetary stimulus. They are in danger of being exposed as emperors without clothes.

*Overnight indexed swap (OIS) rates incorporate market expectations of the average level of overnight interest rates over the term of the swap.

They have – see below and previous post.

Global six-month real narrow money expansion – the main forecasting indicator employed here – was stable in May at a solid level by historical standards. Monetary trends, in other words, continue to support optimism about global economic prospects through late 2013 – see first chart.

Leading indicator evidence is slightly less upbeat but also reassuring. A global longer leading indicator derived from the OECD’s country leading indices fell modestly in May, reversing a rise in April. The indicator, however, remains above a minor low reached in March and is at a level historically consistent with respectable economic expansion – first chart.

The fall in the leading indicator in May was due to the emerging E7 component. The G7 component, by contrast, rose solidly for a second month – second chart.

The above evidence is relevant for economic performance over the next six months. Prospects for 2014 will depend mainly on monetary developments during the second half of 2013. A negative possibility is that a rise in inflation will put downward pressure on real money growth. The six-month change in global consumer prices reached an unusually low level in early 2013 but has started to recover, with a further increase suggested unless commodity prices weaken – third chart.

Such a scenario is only a possibility – the judgement here on the global economic cycle will remain positive pending a significant decline in both real money growth and the longer leading indicator.