Eurozone monetary developments remain mixed, with broad money soft but narrow money strengthening. (Real) narrow money has historically been a much better leading indicator of the economy so this mix is judged here to be positive, cautioning against consensus gloom*. Sluggish broad money, moreover, increases the probability of further ECB easing.

Broad money M3 fell by 0.1% in March, causing six-month growth to slip from 1.5% to 1.4%, or 2.8% annualised. Narrow money M1, by contrast, rose by 0.5%, pushing six-month expansion up from 3.1% to 3.6% – 7.3% annualised.

A geographical split is available for M1 (i.e. overnight) deposits, which comprise 83% of the aggregate. Eurozone-wide real M1 deposits (i.e. deflated by consumer prices) climbed 3.3% in the six months to March, or 6.7% annualised. This is the largest six-month increase since February 2010, when the Eurozone economy was expanding solidly – see chart. (M3, incidentally, was contracting in early 2010.)

Crucially, real M1 deposits are now growing respectably in the periphery (i.e. Italy, Spain, Greece, Ireland and Portugal) – 2.7% in the latest six months versus 3.6% in the core. Periphery / core divergence warned of the “crises” of recent years but the gap is now the smallest since 2009. The six-month change was positive in all five peripheral economies in March.

The core / periphery distinction, indeed, is no longer helpful: the six-month change was stronger in March in Italy and Spain than in the Netherlands, Belgium and France – the latter still negative. German growth remains much the strongest of the major economies – 5.6%, or 11.5% annualised.

*Narrow money is held mainly for transactions purposes whereas broad money is dominated by savings deposits. Households / firms are likely to increase their transaction balances ahead of a rise in spending. Broad money can be unchanged or even fall, for example if there is a simultaneous shift of savings out of banks into markets, to the extent that this transfer is reflected in a contraction of banks’ balance sheets.

GDP grew by 0.3% (0.31% before rounding) between the fourth and first quarters versus an above-consensus estimate here of a 0.2% gain – see Friday’s post. As expected, the rise was driven by solid expansion in the dominant services sector (+0.6%), which offset weakness in construction (-2.5%), with little contribution from industrial production (+0.2%).

The 0.3% GDP increase probably understates economic performance because 1) construction output is likely to have been affected by poor weather and 2) the recent pattern has been for initial estimates of the GDP change to be revised up. GDP would have risen by 0.48% if construction output had been stable last quarter, as suggested by a modest recovery in new orders in late 2012. The quarterly GDP change, meanwhile, has been revised up by 0.15% on average since the start of 2009 (i.e. comparing the initial estimate with the latest data vintage). Taking both considerations into account, “true” growth may have been 0.5% or more.

Today’s news should, thankfully, put to rest silly “triple dip” commentary – silly because the fourth-quarter GDP decline was entirely attributable to a reversal of the Olympics boost in the third quarter so clearly did not signal underlying economic contraction.

The focus now is on how much longer the “double dip” of the fourth quarter of 2011 and first quarter of 2012* survives in the official data. The quarterly GDP changes in the two quarters have so far been revised from an initially-reported -0.3% and -0.2% respectively to -0.1% and -0.1%. As previously explained, the double dip has already disappeared in onshore GDP data (i.e. excluding North Sea oil and gas production).

GDP last quarter was still 2.6% below the peak reached in the first quarter of 2008 but the onshore shortfall is significantly smaller, at 1.7%. The latest onshore GDP index estimate, of 104.5*, is 0.4% below the annual maximum of 104.9 reached in 2007. Moderate further growth in the remaining quarters of 2013, in other words, would result in a new annual high this year.

The sectoral detail in today’s report highlights a continuing depression in the (tiny) agricultural sector – output fell by 3.7% last quarter to stand 14.2% below a peak reached in the second quarter of 2008. Upward pressure on food prices may persist.

*GDP also fell in the second quarter of 2012 but this was attributable to an additional bank holiday.
**Based on 2009 = 100.

Global bank reserves are monitored here as an indicator of central bank policy rather than because they have a significant direct implication for the economy. Reserves can sometimes signal policy shifts that are not associated with a change in official interest rates. This may be useful for anticipating market developments given the importance of policy for investor “risk appetite”.

As previously discussed, aggregate reserves held at the Fed, ECB and Bank of Japan fell to a 12-month low in early March as a repayment of LTRO borrowing by Eurozone banks offset US and Japanese QE. The ECB’s willingness to allow this liquidity drain was a signal of a neutral or even restrictive policy bias and was reflected in a firming of short-term market interest rates (e.g. the three-month EONIA swap). The fall in G3 reserves suggested that the ECB’s “stealth tightening” was more significant than continued US / Japanese easing. The shift away from aggregate accommodation may have contributed to risk assets losing momentum recently.

The G3 total, however, has rebounded strongly over the last month as the Eurozone LTRO repayment has slowed, US QE has continued and Japanese reserves have reconnected with their (now-steeper) expected path – see chart. Aggregate reserves are currently only 4% below the February 2012 high and are certain to move significantly above it over the remainder of the year – the illustrative projection* in the chart shows them climbing 22% by end-2013.

The projection may be conservative if the ECB, as widely expected, responds to recent soft economic news and a fall in inflation by launching further easing. A cut in the headline refinancing rate would not, in itself, expand reserves. The ECB could introduce a new facility allowing banks to borrow at a lower rate (0.25%?) against SME loans, echoing the Bank of England’s funding for lending scheme. Take-up, however, could be modest and drawn-out, judging from UK experience, implying no big impact on reserves.

Global growth may be peaking but significant weakness may be necessary to trigger a bearish market scenario, given ongoing liquidity support. The forecasting indicators monitored here, while moving lower, have yet to signal such weakness.

*The projection assumes that the Fed lowers securities purchases from $85 billion to $40 billion per month during the second half while the BoJ implements its recently-announced QE plan and Eurozone LTRO repayments taper to zero by mid-2013.

UK public sector net borrowing, excluding the temporary impact of financial interventions and the transfers of the Royal Mail pension scheme and the Bank of England’s QE income, was £120.6 billion in 2012-13 – marginally below the Office for Budget Responsibility forecast of £120.9 billion and an outturn of £120.9 billion in 2011-12. The Chancellor, therefore, has avoided the embarrassment of a rise in  “underlying” borrowing, although only because of a late-year effort to defer some spending into 2013-14.

Or has he? The above measure, on which media reporting appears to be focusing, still includes a one-off benefit from the transfer of profits of the Bank of England’s Special Liquidity Scheme (SLS) in April 2012. If SLS flows are also excluded, borrowing was £123.0 billion in 2012-13 versus £120.2 billion in the prior financial year.

Does anyone except the Chancellor and Ed Balls care? The “big picture” is that deficit reduction is proving painfully difficult but any feasible alternative strategy – whether involving more or less “austerity” – would probably make only a minor difference to the economic and fiscal outlook.

Since January, the key forecasting indicators followed here have been suggesting a peak in global economic growth in spring 2013. According to some commentators, recent sizeable falls in some commodity prices signal that a big slowdown is already under way. On closer inspection, however, the message from commodity markets is ambiguous.

Precious metals, of course, have fallen hardest but are not a good coincident indicator of the economy. The pessimists place greater weight on recent declines in crude oil and base metals. Yet a broad measure of industrial commodity prices – the Journal of Commerce (JoC) index – has so far displayed limited weakness and remains above its level at end-2012.

The JoC index comprises 18 commodities*, including crude oil and six base metals, with weights designed to reflect importance in economic activity. Index movements correlate reasonably closely with changes in global industrial output – see first chart.

The JoC measure fell sharply in late 2011 following a mid-year industrial slowdown. A smaller decline occurred in mid 2012 despite more pronounced economic weakness. The index, however, rallied in late 2012 / early 2013, confirming a pick-up in global industrial expansion.

At Friday’s close, the JoC index was still 8% higher than six months earlier (i.e. at end-October). Weakness in oil and base metals, in other words, has yet to generalise to other industrial commodities.

This suggests an alternative, positive interpretation of recent developments – a lower oil price represents a favourable supply shock to a global economy that continues to grow respectably, as evidenced by resilience in a broad basket of industrial commodities.

The oil price fall has already contributed to a decline in global inflation – the six-month change in consumer prices, seasonally adjusted, eased to a 30-month low in March. This, in turn, has sustained global real money expansion at a healthy level despite slower nominal monetary trends – second chart.

The recent fall in the US retail gasoline price has yet to feed through fully to the consumer prices index – third chart. The retail price, moreover, should decline further if the wholesale price remains at its current level.

The central scenario here remains for global growth to moderate from the spring but remain respectable – see previous post. Recent commodity price developments, rather than being a reason for increased pessimism, are consistent with this forecast.

*The constituents are cotton, burlap, steel, copper, aluminium, zinc, lead, tin, nickel, hides, rubber, tallow, plywood, red oak, benzene, crude oil, ethylene and natural gas.