The forecast here that the MPC will suspend QE at its meeting next week is supported by the “MPC-ometer” model discussed in previous posts. This attempts to predict the monthly decision based on the latest values of 12 economic and financial inputs, including business / consumer confidence measures, GDP growth, inflation, wage increases, measures of price expectations, credit spreads and the stock market.

The provisional model reading for November is negative, indicating an easing bias, but within the range consistent with no change in policy – see chart. This incorporates new data for 10 of the 12 inputs, with the remaining two components – from the PMI manufacturing and services surveys to be released on Thursday and Monday respectively – assumed to be unchanged from last month. The PMIs would need to weaken sharply to tip the model into the easing zone.

The no change prediction has been influenced by stronger third-quarter GDP growth (adjusted for the bank holiday distortion), a rise in consumer inflation expectations, firm stock prices and a fall in interbank interest rates, among other factors.

Note that the model correctly predicted the launch of QE2 in October 2011 and its extension in February. It also signalled the further £50 billion addition in July, though was early, turning dovish from May.

US stocks have displayed a positive correlation with bank reserves (i.e. banks’ account balances at the Fed) since QE1 was launched in late 2008. A post on 18 September noted that the Dow Industrials index, then at 13,553, was 1,300 points above the level implied by the current level of reserves, based on the historical relationship. Put differently, the market seemed already to be discounting unsterilised QE3 bond purchases of $40 billion per month sustained until spring 2013.

Since the prior post, the Dow has corrected while QE3 has started to boost bank reserves. (The latter effect has been slow to come through because of delayed settlement on the Fed’s purchases of mortgage-backed securities.) The index deviation from the level implied by current reserves, therefore, has fallen to 970 points. The Dow, moreover, is now slightly below the “forecast” for the end of the first quarter of 2013, assuming that the Fed maintains a $40 billion monthly rate of QE3 purchases – see red dotted line on chart.

“Operation Twist”, under which the Fed swaps $45 billion a month of short- for longer-term Treasuries, is scheduled to finish at the end of 2012. Many commentators expect the Fed to boost QE3 bond purchases to $85 billion a month at this time. The implied level of the Dow at the end of the first quarter under this scenario is more than 13,700, 600 points higher than currently – dotted green line.

This analysis, admittedly simplistic, suggests that the correction in equities is creating a buying opportunity, assuming that the Fed maintains its commitment to liquidity expansion at least through next spring – plausible given perceived economic risks stemming from the “fiscal cliff” and global fragilities.

Non-financial broad money (i.e. M4 held by households and private non-financial corporations) increased by a modest 0.2% in September but six-month growth rose again to 2.6%, or 5.3% annualised – the fastest since May 2008. Such a pace, if sustained, is probably incompatible with achieving the 2% inflation target, allowing for an upward trend in the velocity of circulation stemming from super-low interest rates.

Deflated by seasonally-adjusted consumer prices, non-financial M4 rose by 1.3% (2.7% annualised) in the six months to September. This is down from a peak of 1.6% in June but still higher than in any month between May 2009 and April 2012. Similar real growth in early 2009 preceded a year of solid economic expansion – non-oil GDP rose by 2.5% between the third quarters of 2009 and 2010.

“Monetarist” economists of a dovish persuasion argue that QE has been key to the money supply pick-up so an extension is necessary to prevent a relapse. There are two counter-arguments. First, recent gilt-buying will probably have significant lagged effects and, as noted, current money growth is probably too high. This argues for suspending QE pending clarification from the data about underlying monetary strength.

Secondly, QE is not the sole driver of faster monetary expansion – there has also been a significant positive contribution this year from banks’ reducing their non-deposit sterling funding. This trend may continue, with banks using cheap FLS borrowing to buy back debt. FLS should also lead to some revival in private-sector lending: one glimmer of hope is a moderation in the annual decline in sterling credit facilities – including loans arranged but not yet drawn down – from 11.1% in August to 6.6% in September, the smallest since August 2010.

Rather than a monetary slump should QE end, the main domestic threat to economic prospects is another inflation squeeze on real money expansion – the six-month change in seasonally-adjusted consumer prices has already started to firm, as the chart shows. However, recent oil price weakness and sterling appreciation – if sustained – should temper the near-term inflation pick-up.

Eurozone six-month real M1 expansion – the best monetary leading indicator of the economy – fell back in September but remains solid at 2.0% (4.1% annualised). It continues, in other words, to suggest a recovery in region-wide economic activity in late 2012 / early 2013.

Peripheral real M1 deposits fell in the six months to September but the pace of contraction has slowed.

Peripheral real M1 deposits, indeed, rose in August and September – the following chart shows monthly movements. The six-month change may well turn positive in October as a large April decline drops out of the comparison.

Among the large economies, the key trends are German strength, Italian improvement and Spanish weakness. The six-month changes in real M1 deposits in Italy and France are now similar. With the ECB’s OMT backstop in place, a 270 basis point spread between 10-year Italian and French government yields may not be warranted by Italy’s higher debt level. (General government debt amounted to 126.1% of GDP in Italy and 91.0% in France at the end of the second quarter, according to Eurostat. The IMF projects a general government deficit of 2.7% of GDP in Italy in 2012 versus 4.7% in France.)

The better-than-expected third-quarter GDP result is consistent with the forecast here that the economy would regain momentum during the course of 2012 in lagged response to faster real money supply growth since late 2011 – see, for example, a post in May. With monetary trends improving further in recent months, this upswing should be sustained at least through next spring – see chart.

The 1.0% quarterly rise is flattered by an unwind of the Jubilee bank holiday drag in the second quarter and a probable positive net impact from the Olympics / Paralympics. Most of the holiday distortion can be removed by comparing the third-quarter GDP level with the first rather than second quarter. If the third-quarter result is assumed to have been inflated by 0.2% because of the Olympics / Paralympics, “underlying” GDP was 0.4% higher than in the first quarter, following a 0.7% fall over the previous two quarters (i.e. between the third quarter of 2011 and first quarter of 2012).

A 0.2% Olympics / Paralympics boost takes into account the direct impact of ticket sales but assumes that other positive effects displaced activity elsewhere in the economy. This seems consistent with official “nowcasts” of output in the services, industrial and construction sectors in September (i.e. after the Olympics had finished) incorporated in the third-quarter GDP estimate – the implied monthly level of GDP is 0.2% below the quarterly average.

The strong third-quarter GDP rebound confirms that the second-quarter fall was entirely due to the bank holiday distortion. The economy, in reality, contracted in only two quarters – the fourth quarter of 2011 and the first quarter of 2012. GDP fell by 0.4% and 0.3% in the two quarters, or only 0.2% and 0.2% excluding oil and gas production. While satisfying the commonly-used “two-quarter rule”, it is questionable whether this period of weakness really qualifies as a “recession”, in the sense of a “pronounced, pervasive and persistent” decline in economic activity – particularly in view of the resilience of the labour market.

Today’s news supports the forecast here that the MPC will pass on more QE at its 7/8 November meeting, barring external calamities.

An October rise in the “flash” manufacturing PMI produced by private research firm Markit suggests that the Chinese economy is slowly regaining momentum, consistent with faster real M1 expansion since the spring – see previous post. The key new orders index remains below the supposedly “breakeven” 50 level (49.7) but similar readings historically have been associated with respectable industrial output expansion – see first chart. (The “official” PMI produced by the National Bureau of Statistics – regarded here as more authoritative than the Markit version – will be released at the start of November.)


The scenario of a turnaround in China lifting regional activity is supported by a sharp fall in the proportion of Asian equity analysts downgrading company earnings forecasts in September and October – analysts should reflect firms’ own views about the sales / profits outlook. The “revisions ratio” (i.e. the net proportion of forecasts upgraded over the month) for companies in the MSCI Far East excluding Japan index reached a 19-month high in October, suggesting a reversal of recent weakness in industrial output – second chart.


There was less promise in Eurozone flash PMI and German Ifo surveys for October also released today – headline measures undershot expectations. The Eurozone manufacturing new orders index, however, is holding just above a low reached in May, while Ifo manufacturing expectations rose marginally, breaking a five-month string of declines – third chart. Solid German real money growth continues to suggest that industrialists’ angst is exaggerated and the economy will improve significantly by early 2013 – fourth chart. (September money numbers are due for release tomorrow.)


The UK CBI manufacturing survey for October was mixed but on balance encouraging, with the expected output balance at its highest since April 2011 – fifth chart. (Such expectations are a better leading indicator of activity than order books, which weakened sharply.) Price-raising plans, however, rebounded, signalling a probable reacceleration of CPI goods inflation into early 2013 – sixth chart.