Japanese money growth remains weak but may be regaining momentum. Along with a fading impact of April’s sales tax rise, this suggests better economic performance in early 2015.

QE enthusiasts expected money growth to balloon in 2013-14, supporting a strong economy. A post in April 2013 explained that this was unlikely. Annual growth of broad money M3 was 2.5% in August, unchanged from March 2013, just before the Bank of Japan (BoJ) launched full-scale QE. Narrow money M1 expansion has been similarly static – 4.2% versus 4.1%.

Examining six-month rather than annual changes, M1 and M3 grew solidly during the second half of 2013 but slowed sharply from year-end – see first chart. With consumer prices boosted by April’s sales tax rise, the six-month changes in real M1 and M3 turned negative, warning that the economy was likely to disappoint forecasts – second chart. GDP fell by a much larger-than-expected 1.8% (7.1% annualised) in the second quarter and hopes of a strong third-quarter rebound have faded.

Six-month M1 and M3 growth, however, bottomed in July, recovering modestly in August. The sales tax rise, meanwhile, will drop out of six-month consumer price inflation in October. Real money growth, therefore, should resume this autumn, in turn implying a revival of economic momentum during the first half of 2015.

Currency-adjusted, US equities have outperformed Japanese stocks by 10% year-to-date, consistent with a large real narrow money growth gap in favour of the US in early 2014 – third chart. This gap is on course to narrow significantly, suggesting that the relative attraction of the US market is waning.

The global longer leading indicator* followed here rose in July, supporting optimism about near-term economic prospects.

The leading indicator fell between June and December 2013, correctly signalling an economic slowdown during the first half of 2014. Six-month industrial output expansion peaked in December 2013, falling through June 2014 – see chart.

The leading indicator rebounded strongly in early 2014 and has remained solid more recently. Industrial output growth recovered in July and should move higher through late 2014.

The indicator has been boosted by a rising emerging E7 component, suggesting that emerging-world economic news will surprise positively.

A post last week noted that global real narrow money expansion moderated between March and July, a trend that may have continued in August, judging from weaker US data. Real money typically moves slightly earlier than the leading indicator, and is less subject to revision. The central view here is that the global economy will expand solidly through late 2014 but slow in early 2015.

*Global = G7 developed plus E7 emerging economies. The indicator is derived by transforming and aggregating OECD country leading indicator data.

US narrow money rose strongly during the first half of 2014 but slowed in July and probably contracted last month, judging from weekly data through 25 August. Barring a strong September rebound, this suggests that the economy will lose momentum in early 2015.

Changes in real narrow money expansion precede economic growth fluctuations by about six months, according to the monetarist forecasting rule followed here. This relationship is strongest empirically in global data but is also informative at the country level.

Six-month growth of US real narrow money rose significantly between November 2013 and June 2014, suggesting strong economic performance during the second half – see previous post. Six-month industrial output expansion reached a 46-month high in July and July / August business surveys have been buoyant, with the new orders components of the ISM manufacturing and non-manufacturing surveys achieving their best levels since 2004 and 2005 respectively.

Monetary strength, however, reversed abruptly last month. Narrow money is likely to have contracted by about 0.75% in nominal terms, with six-month real growth falling to its lowest since November – see chart.

Monthly money supply changes are volatile and the August fall could be reversed in September. A bumper increase, however, would be required to push six-month real narrow money growth back up to its mid-year level.

Narrow money is held mainly for transactions purposes and changes usually occur ahead of spending variations, explaining its leading properties. US spending plans, in other words, may be turning more cautious, perhaps because of approaching Federal Reserve policy tightening.

Slower US real narrow money expansion suggests that the global measure tracked here will moderate further in August – see Wednesday’s post.

The UK 2008-09 recession may no longer warrant the label “great”. GDP is now estimated to have declined by 6.0% over five quarters in 2008-09 versus 7.2% over six quarters previously. The Office for National Statistics (ONS) has repeatedly claimed that the 2008-09 recession was the deepest in post-war history. This remains true – just – on the revised data: the 6.0% drop compares with a 5.9% reduction in the 1979-82 recession.

A comparison of the two recessions, however, should take account of North Sea oil and gas production, which rose in 1979-82 but fell in 2008-09, for reasons unrelated to the economic cycle. Excluding such production, the decline in output was marginally larger in 1979-82, i.e. 6.3% versus an estimated 6.2% in 2008-09 – see chart*.

Non-North Sea output, moreover, has risen by significantly more than overall GDP since the recession trough – an estimated 10.5% versus 9.3%. Output is still lower, relative to the pre-recession peak, than at the equivalent point in the 1980s but the shortfall is modest – an estimated 2.1% – and could easily disappear in future ONS revisions.

The new data suggest that non-North Sea output began falling in the third quarter of 2008, one quarter later than overall GDP, i.e. the onshore recession lasted four rather than five quarters. The later entry fits better with monetary developments: real narrow money started to contract in early 2008 and typically leads activity by about six months.

*Non-North Sea output is measured by gross value added (GVA) excluding oil and gas. GVA equals GDP minus the difference between taxes on production and subsidies. GVA ex oil and gas for 2007 Q1 to 2014 Q2 was estimated from the GDP revisions and previously published data.

Global economic growth should firm further near-term but is likely to moderate again in late 2014 / early 2015, judging from July money supply data.

The forecasting approach here focuses on the six-month rate of change of global real narrow money*. This fell significantly between May and November 2013, correctly signalling that economic momentum would slow in the first half of 2014, allowing for the usual half-year lead. Global six-month industrial output expansion appears to have bottomed in June, based on partial July data – see first chart.

The six-month real narrow money change fully recovered its 2013 fall in early 2014, suggesting a rebound in economic growth into the autumn. It has, however, drifted lower more recently, though remains well above the November 2013 low. Economic news, therefore, may surprise positively near term before turning mixed in late 2014. (The longer leading indicator followed here is expected to confirm this assessment – a July reading will be available on Monday 8 September.)

The country detail is interesting. In developed markets, the six-month real money change has been strongest in the US and weakest in Japan, consistent with recent economic performance – second chart. This gap should narrow: US strength is fading and the Japanese reading will rebound as the April sales tax rise drops out of the six-month calculation. Eurozone real money growth, meanwhile, is firming, suggesting improving prospects. A recent sharp slowdown in Canada may signal coming economic weakness.

In emerging markets, real narrow money trends are positive in Mexico, China and Korea** but negative in Russia and, particularly, Brazil – third chart. The Mexican / Brazilian divergence has been reflected in economic performance, with GDP rising by 1.5% and falling by 0.7% respectively between the fourth quarter of 2013 and the second quarter of 2014. Indian narrow money is growing strongly in nominal terms but a rebound in inflation has held back real growth.

*Global = G7 plus emerging E7. Real = deflated by consumer prices. Narrow money = currency plus demand deposits (or nearest available measure).
**Korea latest = June.

UK narrow money growth slowed in July while broad money growth was little changed: monetary trends, overall, appear consistent with continued solid economic expansion through early 2015.

The preferred narrow and broad aggregates here are M1 and M4 excluding financial sector deposits, which are volatile and contain less information about near-term economic prospects. Six-month growth of real non-financial M1 fell to 3.3% (not annualised) in July, the lowest since March 2013 but still strong by historical standards. Six-month real non-financial M4 expansion was 1.4%, equal to its average over the past year – see first chart.

The decline in narrow money growth in July reflected a large movement of funds out of household sight deposits into cash ISAs to take advantage of an increased annual investment allowance of £15,000. These funds would normally have been invested over April-June, suggesting that M1 expansion was inflated in these months, i.e. the July reading represents a return to trend.

The “big picture” is that real narrow money growth rose substantially in 2011-13 ahead of 2013-14 economic strength and remains at an expansionary level despite recent moderation. Stable real broad money growth supports the view that there has been no material change in the monetary environment.

The August MPC minutes cited solid expansion of corporate broad money holdings as a reason for optimism about business investment. This was sustained in July, with a six-month increase in real M4 held by private non-financial corporations (PNFCs) of 3.4% – second chart.

Banks are continuing to widen their interest margin on household sector business, according to interest rate data released with the monetary statistics. The average rate paid on household deposits fell by a further 2 basis points to 1.14%, while the average lending rate was unchanged at 3.93%*. The lending / deposit rate spread, therefore, rose to 2.79%, the highest since August 2010 – third chart.

*Lending / deposit rates on outstanding stocks estimated from interest rate / volume data for different types of business.