The global economy has strengthened in early 2013 – the six-month change in G7 plus emerging E7 industrial output rose from -0.2% in September 2012 to an estimated 2.4% in March (not annualised). This pick-up was predicted by faster global real narrow money expansion between spring and autumn 2012 – monetary trends lead activity by about six months, according to the “monetarist” rule.

The forecast here has been that global growth would moderate but remain respectable from spring 2013, reflecting a minor slowdown in real money expansion in late 2012 / early 2013. The six-month change in G7 plus E7 real money, however, edged higher again in March and is solid by historical standards – see first chart. The global economy, therefore, is unlikely to slow much over the summer. Incoming news, indeed, may beat current conservative expectations.

Global real money expansion is lower than last autumn only because of a slowdown in the US – trends elsewhere have improved. As previously discussed, the US narrow money numbers may have been affected by the removal of unlimited insurance on demand deposits at the end of 2012, prompting a shift into interest-bearing deposits or repos. Lower US real money growth, in other words, may not signal a material deterioration in economic prospects.

The suggestion that US economic expansion will remain respectable is supported by the latest Fed survey of senior bank loan officers. The net percentage of banks tightening standards on business loans usually surges ahead of significant economic weakness but fell further in April, to the bottom of the historical range – second chart. (Note that the net percentage is plotted inverted. The Fed survey was suspended between 1984 and 1990, explaining the data break.)

Today’s stronger services purchasing managers’ survey for April is further evidence in favour of the “monetarist” forecast here of solid UK economic growth in 2013, reflecting the lagged impact of faster real money supply expansion.

Monetarist optimism contrasts with “creditist” pessimism, based on the idea that a pick-up in bank lending is a precondition of a stronger economy. This notion, however, is at odds with historical evidence that, while money leads the economic cycle, credit is a coincident or lagging indicator. In the US, the Conference Board includes bank business loans and consumer credit in its lagging economic index.

This lagging relationship suggests that bank lending will revive as growth continues to strengthen during 2013. There are already hopeful signs, such as a rise in sterling unused credit facilities in the six months to March,  the first such increase since 2007 – see chart. A credit pick-up, in turn, would provide additional support for monetary expansion.

The authorities, of course, will claim that a recovery in bank credit reflects the success of the funding for lending scheme and will try to argue that this recovery is driving a stronger economy, rather than vice versa.

The monetary foundations for a sustainable economic recovery have been laid. The Bank of England should avoid further policy experimentation and focus on achieving its inflation target while allowing banks to operate in a stable regulatory environment.

Emerging equities have continued to underperform developed markets so far in 2013 but relative monetary trends and valuations suggest an imminent turnaround.

The first chart shows the ratio of MSCI’s emerging equity markets index to its developed markets index – a rise in the line indicates that emerging equities are outperforming and vice versa. This ratio is compared with real (i.e. inflation-adjusted) money supply growth in the Group of Seven (G7) major countries and seven large emerging economies – the “E7”*.

Monetary strength signals favourable economic prospects and liquidity support for markets. The chart shows a relationship between the relative performance of emerging equities and the gap between E7 and G7 real money growth. The index ratio peaked in late 2010 as the gap narrowed sharply, turning negative in early 2011. The glory days of emerging equities in 2009-10 and before the financial crisis, by contrast, occurred against the backdrop of relative monetary buoyancy.

An update in February suggested remaining cautious on emerging markets because E7 real money growth, while improving, had not yet crossed above G7 expansion. Emerging equities have since underperformed by a further 7% but the awaited cross-over has now occurred, based on March money supply data. Monetary trends have strengthened in most of the E7 countries and there have been similar or larger gains in smaller emerging economies not included in the aggregate.

Emerging markets, meanwhile, appear inexpensive: the price to earnings ratio based on forecast earnings over the next 12 months is 10.1 versus 13.2 for developed markets, according to I/B/E/S – second chart. The 23% discount is the largest since 2006.

*The E7 is defined here as BRIC (Brazil, Russia, India, China) plus Korea, Mexico and Taiwan.