Better Eurozone money supply numbers for May hold out hope of a stabilisation in region-wide economic activity later in 2012. The core / periphery split, however, remains unfavourable, implying no end to recessions in the latter grouping.

Commentary on today’s statistics may focus on a further fall in private sector loans in May but credit is a coincident or lagging indicator of the economy, while money leads. The three money supply measures – M1, M2 and M3 – all rose solidly last month, more than reversing declines in April.

Real M1 (i.e. the sum of currency in circulation and overnight deposits, deflated by consumer prices) is the best monetary forecasting indicator of the economy. Its six-month change recovered to 0.5% in May (seasonally adjusted, not annualised) – still weak but the strongest reading since August. Allowing for the typical half-year lead, this suggests that industrial output will stabilise by the autumn – see first chart. Real M3 has a less reliable relationship with future activity but its six-month change also returned to positive territory in May, at 0.7%.

The money measures were boosted in May by bank purchases of government bonds – up from €1.9 billion in April to €28.4 billion, though well below January’s €57.0 billion peak – together with a flow of funds out of longer-term, non-monetary instruments (i.e. deposits and bank bonds of more than two years’ maturity). French banks bought €13.7 billion of government bonds last month – helping to explain a sharp fall in the French / German yield spread over the month – while Italian banks purchased €12.3 billion. Spanish banks’ holdings, by contrast, were little changed for a second month.

A disappointing feature of today’s data is that the recent rise in real M1 has been focused on core countries, with peripheral deposits still contracting, albeit at a slower pace than in early 2012 – the second and third charts show six- and three-month changes respectively. (The periphery is defined here as the three bail-out countries plus Italy and Spain.) The peripheral decline partly reflects ongoing capital flight but this does not diminish the negative economic implications – recessions should extend through the autumn (at least).

The country data also confirm an acceleration of deposit outflows from Greek banks following the inconclusive 6 May election – bank deposits held by non-banks, excluding central government, fell by a record €9.1 billion, or 5.3%, last month.

Annual revisions and methodological changes have resulted in the Office for National Statistics cutting its estimate of the fall in GDP during the 2008-09 recession (i.e. between the first quarter of 2008 and the second quarter of 2009) from 7.1% to 6.3%. Embarrassingly, this almost exactly reverses an upward revision to the peak-to-trough decline – from 6.4% to 7.1% – in the last (delayed) annual update in October 2011.

A 6.3% drop still implies that the 2008-09 recession was deeper than the 1979-81 downturn, when GDP fell by 5.9% – see chart. Likely further substantial revisions in future years, however, could change this story.

GDP in the first quarter of 2012 was still 3.9% below the pre-recession peak – a much weaker performance than after previous recessions. Data for 2011 and beyond, however, have not been subject to the annual supply-and-use balancing process so are especially susceptible to future revision.

The current GDP recovery has been held back by falling North Sea oil and gas production. Interestingly, GDP excluding oil and gas in the third quarter of 2011 was at a similar level, relative to the previous peak, as overall GDP at the same stage of the 1979-81 recession / recovery cycle. (GDP ex. oil and gas figures are unavailable for the earlier period.) The negative divergence in the latest two quarters may reflect the impact of the Eurozone crisis – both directly on exports and, more importantly, indirectly on credit conditions and confidence.

Eurosystem gross lending to banks rose by a further €28.9 billion in the week to last Friday, bringing the increase since late May to €78.6 billion or 5.8%, according to weekly balance sheet figures released yesterday – see chart. (The gross figure comprises “lending related to monetary policy operations” and “other claims”, under which the Greek and Irish “emergency liquidity assistance” (ELA) operations are recorded.)

The rise probably reflects additional borrowing by banks in the periphery to offset continued deposit outflows and finance lending to national governments. The latter is suggested by a large increase in general government deposits at the ECB last week and may explain the recent “successful” Spanish government bond auction.

The implication is that TARGET2 imbalances have increased substantially further in June.

A further lending rise is likely this week, since a total of €206.7 billion has been allotted in weekly and three-month refinancing operations versus a maturing €192.4 billion.

A sharp fall in the widely-watched ISM manufacturing new orders index may intensify worries about emerging US economic weakness – June results are scheduled for release on Monday.

A post two weeks ago suggested that the orders index would decline based on softness in retail sales volumes and a pick-up in earnings downgrades. The forecast has been confirmed by weakness in Federal Reserve regional manufacturing surveys (four out of five released to date) as well as the Korean FKI poll – Korea’s economic structure makes it especially sensitive to the global / US business cycle.

The first two charts below suggest that ISM new orders will fall to about the breakeven 50 level or lower in June or July. Interestingly, a decline is also suggested by the historical cyclical pattern, though to a lesser degree – third chart. A recession signal would require a break below 45 – unlikely. 

Today’s public finances update contained a double helping of bad news: borrowing in April / May 2012 (on the PSNB ex definition that excludes the temporary effects of financial interventions, adjusted additionally for the transfer of the Royal Mail pension plan) was £3.9 billion higher than a year before, while there were substantial upward revisions – of £3.2 billion and £3.8 billion respectively – to outturns for 2011-12 and 2010-11.

Incorporating an adjustment for seasonal variation, a six-month moving average of borrowing has risen from £10.0 billion in December to £11.4 billion in May – see chart. A continuation of the latter run-rate would imply a full-year deficit of £137 billion in 2012-13 versus the Office for Budget Responsibility’s March projection of £120 billion.

The OBR is unlikely to attribute an overshoot entirely to cyclical economic weakness, implying that it may revise its assessment that the government is on track to meet the “fiscal mandate” of cyclically-adjusted current budget balance at the end of a rolling five-year period. The supplementary target of reducing the net debt to GDP ratio in 2015-16 is even more vulnerable, since it is fixed in time and achievement depends on the actual rather than “structural” deficit.

The borrowing rise is unlikely to deter the MPC from launching a further programme of gilt purchases next week but opens it to criticism that such action is designed to head off upward pressure on yields as fiscal plans unravel rather than address a genuine shortage of money in the economy.

Greek budget statistics, if reliable, indicate that the primary deficit (i.e. excluding net interest payments) has declined further in the run-up to the recent elections, despite an ongoing severe recession. The overall deficit has been inflated by a rise in the interest burden but this should reverse following the PSI (private sector involvement) debt restructuring.

The state primary deficit totalled €4.31 billion in the 12 months to May, down from €9.79 billion in the prior 12 months, according to revised data issued today. This represents a fall from 4.4% to 2.0% of GDP – see chart. The recent rate of decline is consistent with achievement of the target in the 2012 Supplementary Budget of reducing the deficit to €1.09 billion or 0.5% of GDP in calendar 2012. (Greece’s IMF programme targets a primary deficit of 1.0% of GDP in 2012 but this is on a wider general government basis including local governments, social security funds etc.)

The overall state deficit, however, was €23.34 billion in the 12 months to May, little changed from €23.46 billion in the prior 12 months, with the fall in the primary deficit offset by a surge in net interest payments from €13.67 billion to €19.03 billion. The shortfall as a proportion of GDP increased from 10.5% to 11.1% because of a contraction in the nominal economy.

The recent debt restructuring will result in net interest payments falling substantially in the remaining seven months of 2012 from their level a year before. Full-year payments are officially projected at €13.05 billion compared with €16.35 billion in 2011. On this basis, the overall state deficit is forecast to fall to €14.14 billion or 6.9% of GDP in 2012, assuming that the primary deficit target of 0.5% is met.

The reduction in the primary deficit from a peak of 7.9% of GDP in 2009 to 2.0% in the latest 12 months is impressive for an economy that has contracted by 16% in real terms from a peak reached in the third quarter of 2008. Recent Greek governments, clearly, have embraced fiscal austerity; taxes, however, may have borne an excessive burden of the adjustment while there has been insufficient structural reform.