Euroland money measures rose solidly in October after a minor September slowdown, with the larger trend continuing to suggest stronger economic performance in 2020. The OECD’s composite leading indicator is also giving a more hopeful message.

Annual growth rates of narrow and broad money were at or near their recent highs in October and well up from late 2018 / early 2019, suggesting that annual nominal GDP expansion will revive in 2020 – see first chart.

Six-month growth rates of real money (i.e. deflated by consumer prices, seasonally adjusted) have been boosted by a recent energy-driven decline in inflation. Real non-financial M1* expansion, the preferred monetary forecasting indicator here, reached a 26-month high in October – second chart.

Real non-financial M1 deposits are growing solidly across the big four economies, with France and Italy currently leading – third chart.

The OECD will release October data for its leading indicators on 9 December but most of the component information is available, allowing a preliminary calculation. The Euroland indicator appears to be stabilising after a steady slide over 2018-19 – fourth chart. A stable reading implies future GDP growth at trend, which for Euroland is estimated by the OECD, EU Commission and IMF at 1.2-1.4% per annum, or about 0.3% per quarter.

*Non-financial = held by households and non-financial corporations.

Global nominal GDP has slowed significantly since late 2017 but recent stronger money trends suggest a reacceleration during 2020. The monetary pick-up could be laying the foundation for a rise in inflation in the early 2020s, consistent with long-term cycle analysis.

Annual growth of G7 plus E7 nominal narrow money has led swings in nominal GDP growth since the late 1990s, by which time E7 integration into the global economy was well-advanced – see first chart. A much longer-term relationship exists in G7-only data – second chart.

G7 plus E7 annual narrow money growth peaked in October 2016, falling significantly over the following two years to a low in November 2018. Nominal GDP growth peaked a year after the money growth peak in Q4 2017 and is estimated to have fallen further in Q3 2019, based on partial data – first chart.

Lows in money growth in January 2001, August 2008 and June 2016 preceded lows in nominal GDP growth by three quarters. The November 2018 money growth low, therefore, suggests that nominal GDP growth is at or near a trough and will revive during 2020.

The narrow money signal is supported by broad money trends: annual growth also bottomed in late 2018 and has risen towards the top of its post-GFC range – third chart. The leading relationship between broad money and nominal GDP broke down around the GFC as the collapse of the shadow banking system resulted in shadow assets / liabilities moving onto banks’ balance sheets, boosting conventionally-measured broad money aggregates.

A recovery in nominal GDP growth would be expected to be reflected initially in real economic activity but inflation would follow if the pick-up were to be sustained. Recent money trends, that is, could be laying the foundation for a rise in inflation in 2021 and beyond. Such an increase would be consistent with the long-term Kondratieff price / inflation cycle.

Nikolai Kondratieff, a Russian economist, conducted research in the 1920s on long-term UK, French and US data on prices, interest rates, trade and production, and found evidence of long “waves” or cycles of around 50 years. Kondratieff argued that prices had reached long wave peaks in 1814, 1873 and 1920.

The breakdown of the gold standard in the 1930s and rapid monetary expansion during and after World War II resulted in a secular rise in the price level. The Kondratieff cycle, however, remained visible in rate of change data – fourth chart. The 1975 peak in PPI inflation rates occurred on schedule.

The average length of the cycle since the late 1600s (i.e. six complete cycles measured from trough to trough) has been 54 years. This suggests another peak around 2029.

Mainstream economists dismiss cycle analysis as the economics equivalent of astrology. There are, however, several reasons for taking seriously the possibility of a coming sustained inflationary upswing.

First, while unemployment rates are expected to rise near term, they are likely to peak well below previous cyclical highs. Wage pressures, therefore, could pick up strongly early in the next economic upswing. Deglobalisation implies less of an offset to domestic labour market tightening from cross-border flows of labour-intensive products and workers.

Secondly, banks are highly liquid and generally well-capitalised, suggesting that bank lending will grow much faster in the next upswing. Lacking other tools to stimulate activity, policy-makers will probably encourage this trend. A lending boom could create the monetary conditions for a sustained inflation rise.

Thirdly, policy defences against higher inflation are being dismantled. Lingering deflation concerns suggest that central banks will be slow to respond to any inflation pick-up. Meanwhile, a growing consensus in favour of fiscal expansion and “new” ideas such as Modern Monetary Theory raise the prospect of monetary financing of rising deficits.

Money and credit trends suggest that Chinese economic momentum will remain weak through H1 2020.

The PBoC today released detailed monetary data for October, allowing calculation of the preferred narrow and broad money measures here, i.e. “true” M1 including household demand deposits and M2 excluding bank deposits held by non-bank financial institutions. Six-month growth rates of the two measures eased further – see first chart.

The monetary slowdown suggests that a rise in two-quarter nominal GDP expansion since Q1 2019 will reverse into H1 2020.

The forecasting approach here emphasises narrow money but the Chinese broad money measure used here (not headline M2) has performed equally well as a leading indicator historically, sometimes moving earlier. Growth of this measure has now retraced most of its recovery since H1 2018.

October credit numbers were also disappointing, with six-month growth of total social financing the lowest since April.

Growth of the three measures peaked in May-June, with subsequent weakness probably related to failures of several regional banks and an associated tightening of funding and credit conditions, which appears to have offset monetary policy stimulus, at least temporarily.

Reflecting Chinese weakness, six-month growth of global (i.e. G7 plus E7) real narrow money growth may have slipped back to 2.3% (not annualised) in October from 2.7% in September – second chart. The US, Japan, India and Brazil have also released October money data, accounting – together with China – for 70% of the global aggregate.

The September-October numbers are above the range over December 2017-August 2019 and suggest that nine-month-ahead economic prospects have improved but a move above 3% is needed to confirm a recovery scenario. This is unlikely without a rebound in Chinese money trends.

Last week’s MPC communications and recent data suggest a cut in Bank rate at the next meeting on 19 December.

The MPC’s latest forecast signals an easing bias: inflation is projected to be below the 2% target in two years’ time (at 1.89%), assuming an unchanged 0.75% level of Bank rate. This contrasts with the August forecast, when the two-year-ahead projection was above 2% (2.10%).

The MPC was understandably reluctant to cut rates, or pre-commit to a reduction, at the start of a general election campaign. The two dovish dissents, however, underlined the shift of opinion signalled by the inflation forecast.

The economy may yet be shown to have entered a recession despite this week’s news of a 0.3% rise in GDP in Q3 (below a Bank staff estimate of 0.4%). The Q3 level was only 0.1% (0.07% before rounding) higher than Q1. Initial estimates tend to be revised down when the economy is weakening – recall the downgrade from +0.2% to -0.7% for Q2 2008, the first quarter of the last recession.

Monthly data show that GDP fell in August and September, and the September level was 0.1% lower than March. GDP is currently estimated to have surpassed the March level for a single month in July but this is questioned by data on total hours worked in the economy, which fell by 0.5% between the three-month periods centred on March and July respectively.

The MPC’s forecast implies high recession risk, with an assessed probability of 31% that GDP in Q1 2020 will be lower than in Q1 2019.

Data since the MPC meeting support the case for easing. As well as the GDP undershoot, yesterday’s labour market report showed a cooling of earnings growth along with a further fall in vacancies and rise in redundancies – see first chart.

CPI inflation fell to 1.5% (1.46% before rounding) in October, consistent with the MPC forecast of a 1.42% average in Q4. The decline reflected gas and electricity price cuts, with the core rate – defined here to exclude energy, food, alcohol, tobacco, education and estimated VAT effects – edging up to 1.7%. Core PPI output inflation, by contrast, fell further and usually leads CPI trends – second chart.

Optimists cite October manufacturing PMI results as evidence that global economic momentum is rebounding. Such hopes appear premature.

The global manufacturing PMI new orders index bottomed at 49.0 in June / August, reviving to the 50.0 breakeven level in October. A turnaround had been suggested by a revival in global six-month real narrow money growth in early 2019 – see first chart.

Real money growth, however, stalled between February and August 2019. Allowing for the usual lead, a further recovery in PMI new orders could be delayed until late Q1 2020.

The October rise in the orders index, moreover, was driven by the investment goods component, with consumer and intermediate goods orders little changed – second chart. Business investment, however, usually follows profits, which remain under pressure from weak sales and falling margins. The ratio of US non-farm business prices to unit labour costs, for example, fell in Q3, suggesting a decline in the national accounts measure of domestic non-financial corporate profits – third chart.
 

The US / China economic dispute escalated in August / September, possibly resulting in some front-loading of investment goods orders ahead of scheduled US tariff hikes.

The global services PMI survey, meanwhile, weakened further in October, though is dismissed by the bulls as a lagging indicator. This may be unwise: the services new business index correlates with manufacturing consumer goods orders, with the relationship suggesting a decline in the latter – fourth chart.

The employment indices of the two surveys signal fading income support for consumer spending, with October readings the lowest since 2009-10 – fifth chart. A rise in unemployment would reinforce a recent trend towards credit tightening by bank loan officers (see last week’s Fed survey), impairing transmission of monetary policy stimulus.

Short-term leading indicators suggest a modest revival in global economic momentum into early 2020 but – like monetary trends – have yet to signal a full recovery.

The forecasting approach here seeks confirmation for global monetary signals from a shorter-term leading indicator derived from the OECD’s country leading indicators. The OECD is scheduled to release September data for its indicators on 12 November but most of the component information is already available, allowing an independent calculation.

The six-month rate of change of the leading indicator bottomed in February and continued to firm in September – see first chart. Allowing for a typical lead time of five months, this suggests a revival in industrial output momentum from Q3 into early 2020.

Leading indicator growth, however, remains weak, mirroring the limited recovery in global six-month real narrow money expansion until September. Economic momentum, therefore, is unlikely to pick up significantly before Q2 2020.

The judgement here is that six-month real narrow money growth needs to move sustainably above 3% (not annualised) to signal a full recovery, in the sense of a return to trend or above-trend GDP expansion. This is not guaranteed despite policy easing.

The recent sharp back-up in bond yields will have a dampening effect on money trends, which could also be held back by an autonomous tightening of credit conditions as corporate defaults and unemployment rise in lagged response to economic weakness, causing banks and other lenders to become more risk averse. There were signs of this in the Fed’s October senior loan officer survey released this week: an average of net percentages of banks tightening credit standards across various loan categories rose to the highest since January 2017 – second chart.

G7 October consumer surveys, meanwhile, showed a further rise in concern about labour markets, suggesting a pick-up in unemployment into early 2020 – third chart. Official jobless numbers rose in the latest month in the US, Japan, Germany, the UK and Italy (plus Spain), though fell in France and Canada.