A post last week suggested that a €37.8 billion fall in Eurosystem lending to the banking system during September reflected a flow of capital back to the periphery in response to the ECB backstopping sovereign bond markets; such a flow eases funding pressures on peripheral banks, reducing their recourse to official support. This suggestion was supported by subsequent September balance sheet data from Banco de Espana and Banca d’Italia, showing declines in lending to banks of €29.5 billion and €3.9 billion respectively.

Eurozone-wide lending has continued to fall so far in October – the ECB’s weekly balance sheet shows a €17.4 billion reduction last week, while this week’s seven-day and one-month repo operations resulted in a net withdrawal of €14.3 billion. A reasonable hypothesis, therefore, is that 1) the Draghi plan has succeeded in attracting funds back to the periphery, 2) this will be reflected in an increase in the money supply in September / October and 3) such an increase will lay the foundation for a stabilisation and recovery in economic activity in early 2013.

Any break in this potentially virtuous circle should be signalled by a renewed rise in ECB lending.

The OECD’s composite leading indicators are useful for confirming signals about future economic activity from real money supply trends. The OECD, however, regularly misinterprets its own data.

A case in point is the release issued today to accompany August indicator results; this claims that “most major economies will continue to see weakening growth in the coming quarters”. Yet a forecasting indicator of global expansion calculated here by combining and transforming the OECD data rose for a second consecutive month – see first chart. Allowing for a typical three-month lead, this suggests that the six-month change in global industrial output will bottom in September and recover in October / November.

An experimental “leading indicator of the leading indicator”, moreover, rose for a fourth consecutive month in August, hinting at a further recovery in the indicator itself in September and October – second chart. (The “double-lead” indicator is explained in a previous post.) This, in turn, would imply that global firming will extend into early 2013.

These results confirm the positive signal from an earlier pick-up in global real narrow money expansion, first discussed here in July. This pick-up continued in August and will probably extend into September, so another peak in global growth is unlikely before next spring at the earliest – see post from last week.

The improving outlook signalled by monetary trends and leading indicator data has yet to be recognised by a consensus inclined towards bearishness because of ongoing Eurozone fiscal tightening and the risk of the US “going over the cliff”. The IMF faithfully follows the consensus and, according to press reports, will downgrade its global growth prediction this week – a further reason for optimism, given its forecasting record.

Aggregate ECB lending to banks, including “emergency liquidity assistance”, fell by a further €9.8 billion last week, lifting the decline during September to €37.8 billion – see chart. Another significant reduction is likely this week, since banks drew down €102.9 billion in today’s seven-day repo operation versus €117.4 billion last week.

The lending fall suggests that capital is starting to flow back to the periphery in response to the ECB backstopping sovereign debt markets via its “outright monetary transactions” programme. A reversal of capital flight eases funding pressures on peripheral banks, allowing them to reduce their borrowing from the ECB. Such an interpretation requires confirmation from September balance sheet data from Banca d’Italia and Banco de Espana due to be released shortly.

The “monetarist” view here is that recessions in peripheral economies are the result of money supply contraction caused by capital outflows and credit weakness. A return of capital could allow monetary growth to resume this autumn, in turn laying the foundations for an economic recovery from spring 2013. Keynesians, of course, claim that no economic revival is possible while fiscal tightening continues and devaluation remains blocked.

A post in July suggested that global economic momentum would trough in autumn 2012 and revive into year-end, based on a recovery in real narrow money expansion from a spring low. Manufacturing purchasing managers’ surveys for September are consistent with this forecast: a weighted average of G7 PMI new orders rose for a second month, with the increase confirmed by a recovery in the equity analysts’ revisions ratio – see first chart.

A stronger G7 new orders reading had been signalled by a revival in Korean manufacturers’ expectations in August – Korean industry is a bellwether of the global economic cycle. This recovery, noted in a post a month ago, extended in September, increasing the probability that the turn in the G7 orders measure is genuine – second chart.

Early data had suggested that global six-month real narrow money expansion would fall back in August – see here. Eurozone and UK statistics released over the last week, however, have resulted in this decline being revised away – third chart. With US weekly numbers strengthening, the global real money growth measure could rise again in September, implying that the forecast economic upswing should last at least through March 2013, allowing for the usual six-month lead.

Consensus gloom about UK economic prospects continues to be contradicted by solid real money expansion, promising a return to respectable growth in late 2012 and early 2013.

The preferred UK money measures here are non-financial M1 and M4, comprising holdings of households and private non-financial corporations (i.e. excluding volatile financial sector holdings). These rose by 0.7% and 0.6% respectively in August, lifting six-month increases to 3.0% and 2.6% (not annualised). Six-month growth is the fastest since January 2010 for M1 and May 2008 for M4 – see first chart.
 
Nominal money trends interact with inflation to determine economic prospects. Last year’s inflation spike resulted in a contraction of real money, reflected in economic weakness in late 2011 and early 2012 – second chart. Stronger nominal money expansion coupled with lower inflation have reversed the squeeze this year – real non-financial M1 and M4 (i.e. deflated by seasonally-adjusted consumer prices) rose by 1.9% and 1.5% respectively in the six months to August.

Current real money growth rates are similar to early 2009 ahead of a year of solid economic expansion – non-oil GDP rose by 3.0% in the five quarters from the second quarter of 2009 to the third quarter of 2010.

The consensus interpretation of today’s monetary statistics will be downbeat because of continued weakness of credit – non-financial M4 lending fell by 0.1% in August, for a six-month decline of 0.3%. An economic pick-up in late 2012 should demonstrate, once again, that money is a leading indicator while credit lags – but don’t expect the consensus to acknowledge its error or abandon “creditist” story-telling.