Chinese monetary and leading indicator data have firmed, suggesting that the economy will regain momentum later in 2012.

The first chart shows six-month growth in industrial output and real money / loans. The 2011-12 economic slowdown was foreshadowed by a fall in real money expansion starting in 2009 and extending to mid-2011 for the broader M2 aggregate and early 2012 for narrow money M1. Real M2 and loans, however, have been growing respectably since late 2011 while M1 has now picked up (although the July six-month change was inflated by an erratically-weak January base – a partial retracement is likely in August).

The monetary message is supported by a leading indicator derived from the OECD’s Chinese leading index, with the indicator firming gently since late 2011 – second chart. (The OECD index includes M2 as one of seven components – the others are production of motor vehicles, fertiliser, steel and buildings, a business survey measure of overseas orders and stock market turnover.)

The forecasting approach here emphasises real M1, which recovered later and has yet to post solid growth. This suggests that economic improvement will be delayed until late 2012 / early 2013 while GDP expansion will remain subdued by the standards of recent years.

As usual, the August Inflation Report predicts a recovery in GDP expansion combined with inflation falling to the target and then below in the second year of the forecast horizon, implying scope for further monetary easing. Medium-term growth prospects, however, are deemed materially worse than in the May Report – GDP is expanding by about 2.25% per annum by 2015 versus 2.75% in May, with the downgrade partly due to a further negative reappraisal of productivity performance.

The predicted recovery in GDP growth in 2013 is viewed here as plausible given the pick-up in real money expansion during the first half of 2012 and the further easing measures announced in July – assuming, of course, that a Eurozone meltdown is avoided. The Governor’s self-congratulation about inflation performance and prospects, by contrast, is premature, recalling a similar “mission accomplished” claim in 2009. Much of the first-half decline reflects commodity price weakness that has since reversed, while core pressures – particularly in the services sector – remain stubborn. Barring a global recession or significant sterling strength, CPI inflation should stay above the 2% target and is likely to be rising – not falling – later in 2013 and in 2014 in lagged response to current monetary stimulus.

Previous posts argued that 1) the US economy would slow from the spring but 2) a recession would probably be avoided, because real narrow money was still growing. The latest monetary data continue to suggest moderate economic expansion: six-month real narrow money growth has stabilised at a respectable historical level – see first chart, which incorporates an estimate for July.

The monetary message is supported by job openings (i.e. vacancies) – a shorter-term leading indicator with a good track record (having turned down in mid-2007 ahead of the 2008-09 recession). June private-sector openings more than reversed a fall in May, with the three-month moving average rising to a new recovery high – second chart.

The continued rally in US equities suggests that investors are discounting both continued economic expansion and meaningful further Fed easing – it is not clear that they will get both. Another risk is that the recent rebound in commodity prices pushes up inflation, causing a renewed slowdown in real money. Summer rallies are often unreliable, the classic example being 1987 – see third chart, which updates a comparison in another prior post.

Recent weakness in Germany and other “core” Eurozone economies was signalled by a contraction in real narrow money in late 2010 and the first half of 2011, discussed in various posts last year, e.g. here. Core real money growth, however, has recovered in 2012, with Germany in the lead. The country’s exporters, meanwhile, will benefit from the slide in the euro versus the yen and a likely revival in emerging-world growth in 2013.

The first chart shows six-month changes in German industrial output and real M1 deposits (i.e. overnight deposits). Real deposits grew by 4.3%, or 8.8% annualised, in the six months to June – the fastest growth since September 2010. The July cut in the ECB’s refinancing and deposit rates, and likely further easing actions, may sustain this pick-up.

The second chart shows the net percentage of firms expecting higher exports together with the yen / euro exchange rate*, plotted inverted (i.e. a rise in the line indicates a cheaper euro). Export expectations have weakened significantly as the global economy has slowed since early 2011 but the balance, nonetheless, remains positive. This may partly reflect German companies gaining market share at the expense of Japanese competitors – the exchange rate versus the yen is the weakest since 2000. German exporters look well-placed to benefit from a recovery in global economic momentum from late 2012 suggested by real money trends – see Wednesday’s post.

Germany is more sensitive than most other major economies to emerging-world growth: Asia ex. Japan and Eastern Europe account for a combined 22% of total goods exports, in turn equal to 9.0% of GDP – the equivalent proportion for the UK is only 2.2%. This year’s emerging-world slowdown has been a drag on German economic performance but E7 real narrow money expansion has started to revive, suggesting improving prospects for 2013 – third chart.

A buoyant German economy next year would be good news for the wider Eurozone – providing the ECB sets monetary policy for the whole group rather than its leading member. Former ECB President Trichet caved to Bundesbank pressure for ill-advised monetary tightening following the 2009-10 economic upswing; based on his actions to date, Sig. Draghi is unlikely to make the same mistake.

*The rate is linked to the DM before EMU’s inception in 1999.