Monetary statistics for June are encouraging for economic prospects in three respects. First, the broad money supply (i.e. M4 holdings of households, private non-financial corporations and financial corporations excluding intermediaries) followed up solid gains in recent months with a further 0.2% increase. While annual growth remains low at 1.2%, broad money rose at a healthy 5.2% annualised rate during the first half of the year.

Secondly, narrow money M1 – on the ECB's definition comprising currency in circulation and overnight deposits – increased by 1.5%, pushing annual growth up to a 26-month high of 8.3%. Hardly anybody bothers to monitor M1 these days but it has proved a better leading indicator than broad money, contracting as the economy entered a recession in spring 2008 but recovering strongly in mid 2009 ahead of a GDP rebound later last year – see first chart.

Thirdly, the corporate liquidity ratio – non-financial corporations' sterling and foreign currency deposits divided by their bank borrowing – rose again during the second quarter, continuing a recovery from a low in the first quarter of 2009, two quarters before the trough in GDP. Excluding the struggling real estate sector, the liquidity ratio is now at the top of its historical range – second chart.

Pessimists will focus on continued weakness of bank lending to the private sector, which contracted at a 1.0% rate during the first half. Last week's news, however, that non-oil GDP rose by 2.0% in the year to the second quarter is convincing refutation of the "creditist" view embraced by many economists and journalists last year that no economic recovery would occur without a revival in lending.

Private sector lending matters more because of its implications for money creation than its direct impact on the economy. Recent lending weakness and the decision to suspend official gilt purchases in February will not prevent a continuing economic recovery because other factors have boosted broad money expansion. Specifically, banks have stepped up purchases of public sector securities (to £23.9 billion during the first half from £10.7 billion in the second half of 2009), there has been a net influx of capital to the UK (resulting in a positive contribution to monetary growth from "external and foreign currency flows"), while banks have slowed capital-raising, relying more on deposits to fund assets (reducing the negative contribution from "net non-deposit sterling liabilities").

Recent Eurozone economic news has been stronger than expected and somewhat at odds with trends in other countries, particularly the US. This could reflect the region's historical tendency to lag the global cycle but is also consistent with relative monetary trends.

As previously discussed, narrow money, M1, is likely to be a better guide to monetary conditions at present than broader measures, with the demand to hold broad money depressed by negative real deposit interest rates. Eurozone real M1 rose by 2.7%, or 5.5% annualised, in the six months to June, comfortably above growth rates in the US, Japan and, probably, the UK (for which June figures are published tomorrow) – see first chart. Among major developed economies, real M1 expansion is faster only in Switzerland and Canada – both economies have been growing solidly.

A post in May suggested that relatively strong M1 expansion would contribute to a reversal of the underperformance of Eurozone equity markets earlier in 2010. The region has since rallied relative to the US and Japan – second chart – although non-EMU European markets like the UK and Sweden have also performed strongly, suggesting that monetary trends are not the sole explanation.

The Dow Industrials index has rallied back to within 4% of the "six-bear average" path, based on recoveries after previous large US stock market declines – see chart and prior post for more details. This follows a 10% undershoot in early July.

The average moves sideways into the autumn; the Dow may struggle to exceed it without an improvement in liquidity indicators. (As a follow-up to yesterday's post, the Eurozone monetary base fell again last week – the fourth consecutive decline.)

Equities and other risk assets have rallied partly on hopes of easier monetary policies but major central banks have yet to inject additional liquidity into banking systems.

Previous posts discussed the leading relationship between the US monetary base (i.e. currency plus bank reserves) and US / global equities in operation since early 2009. Stock markets peaked in late April 8-9 weeks after a high in the monetary base in late February while the rally starting in early July similarly followed a trough in the base 8-9 weeks before in early May. The monetary base last week fell to its lowest level since the May bottom, suggesting increased near-term risks for markets – see first chart.

Eurozone trends may also be relevant and are similarly cautionary, with the monetary base in the week before last at its lowest since December (last week's figures are released tomorrow). The recent large decline reflects a fall in demand for ECB credit from stronger banks, partly because new 12-month fixed-rate loans are no longer available. The reduction in excess cash in the system, however, has contributed to unwelcome upward pressure on market rates – second chart.