Previous posts argued that China was easing monetary policy too slowly, risking an economic “hard landing”. This danger is still present judging from weak April money supply figures.

Slowing inflation and initial easing moves resulted in a pick-up in six-month growth in real M2 late last year but this has reversed more recently, with April’s reading the lowest since October – see first chart. Real M1 is much weaker, contracting over the last six months – similar slippage in 2008 preceded a fall in industrial output.

The three-month repo rate has declined recently, probably reflecting a combination of more generous central bank liquidity supply and market expectations of policy easing – second chart. Time is running out.

OECD leading indices for March released today confirm an incipient slowdown in global growth but monetary trends suggest limited weakness while hinting at a momentum trough in the late summer.

As previously discussed, the approach to forecasting the global cycle employed here relies on two key inputs – six-month growth in global real narrow money and a leading indicator derived from the OECD’s country leading indices. Real money typically leads industrial output by about six months with the leading indicator moving about three months later (i.e. three months ahead of output).

Real money growth peaked in November 2011 and fell sharply through February 2012, suggesting a slowdown in output momentum from a May top, allowing for the usual six-month lead. This prospect has now been confirmed by a February peak in the leading indicator, with the March decline the first since June 2011 – see chart. (Note that the indicator is based on a proprietary transformation of the raw data so cannot be inferred directly from the OECD release.)

Turning points in the leading indicator usually signal the start of a multi-month trend. Six-month real money expansion, however, recovered marginally in March, hinting that February may have marked a trough. If so, output momentum may bottom in August, with the leading indicator reaching a low in May (applying the respective six- and three-month leads).

The risk, of course, is that real money resumes a slowdown after temporarily stabilising in March / April. Recent policy easing in Europe, Japan and some emerging economies should be supportive but could be offset by an “endogenous” tightening of financial conditions if the Eurocrisis escalates. With real money currently still expanding respectably by historical standards, however, the provisional message is that the coming economic slowdown will be modest and possibly short-lived.

The monetarist forecast of a slowdown in the US economy from the spring is supported by recent data but the odds favour a downshift in growth rather than anything worse. Real narrow money is still comfortably higher than six months ago, consistent with an ongoing recovery.


10 out of 11 post-war recessions were preceded by a fall in real narrow money. The exception – the 1953-54 recession – was apparently caused by severe fiscal tightening as defence spending was slashed after the Korean war. A repeat is possible if Congress fails to address the end-2012 “fiscal cliff” – i.e. automatic tax increases and spending cuts – implied by current policies.

The rise in non-farm payrolls slowed to 115,000 in April versus an expected 170,000 (although the gain in the previous two months was revised up by 53,000). Private payrolls, however, were still up by a solid 0.5% from three months before, while aggregate hours worked rose 0.6%.


Suggestions that the labour market is about to go into reverse are not supported by the Conference Board’s employment trends index (ETI), which rose further in April. The ETI is a composite of eight leading indicators: consumers finding “jobs hard to get”, initial unemployment claims, small firms with “hard to fill” positions, temporary-help employees, part-time workers, job openings, industrial production and real business sales.


March job openings – not incorporated in the latest ETI – were similarly encouraging, suggesting a continued uptrend in private payrolls.


Firms have revised up 2012 capital spending plans, according to the Institute for Supply Management semi-annual business survey, with increases of 6.2% and 3.6% now expected in manufacturing and non-manufacturing respectively versus 1.9% and 0.2% in December. Operating rates rose in both sectors, with a weighted average reaching its highest level since spring 2008. The implication that there is limited spare capacity in the economy accords with recent core inflation resilience and casts doubt on estimates by the OECD and others of a large negative “output gap”.

Few economists expect a further expansion of QE at this week’s policy-setting meeting but such an outcome is suggested by a model based on the MPC's historical reaction function.

The “MPC-ometer” uses 12 economic and financial indicators to forecast the monthly policy decision and has performed well since its introduction in 2006, except for several months in late 2010 and early 2011 when it predicted modest tightening – such a shift would have tempered the current inflation overshoot. More recently, the model signalled the launch of QE2 last autumn and its extension in February.

The model has maintained a dovish bias in recent months and shifted further in May, consistent with a £75 billion expansion being announced this week. This mainly reflects the 0.2% fall in GDP in the first quarter but declines in the PMIs and consumer confidence, a further slowdown in pay growth and weaker industrial pricing plans also contributed.

The consensus expects unchanged policy partly because the April minutes suggested that the MPC would ignore another GDP fall. This, however, assumed that the decline would reflect a large drop in construction output, with other sectors expanding. GDP excluding construction, in fact, was flat last quarter, questioning the Committee’s assumption of a pick-up in underlying growth.

The minutes also acknowledged a deterioration in the short-term inflation outlook but – as last year demonstrates – such a negative reassessment need not preclude further easing. The Committee still appears inclined to attribute disappointments to temporary “shocks", with the minutes stating that “(T)here was little solid evidence yet that the balance of risks to inflation in the medium term had changed.”

The MPC-ometer’s forecast assumes that the Committee will – as it has in the past – place more weight on activity than inflation indicators. An unchanged decision this week could signal that its reaction function is shifting in response to the prolonged inflation overshoot – the MPC, in other words, may judge that an increased threat of expectations becoming detached from the target has constrained its ability to respond to economic weakness.