Echoing trends elsewhere, Eurozone June money supply numbers were disappointing, with the narrow M1 and broad M3 measures falling by 0.6% and 0.4% respectively from May. Earlier M1 strength suggests a respectable economic recovery during the second half but this could fade at year-end if June monetary weakness extends into the current quarter.

Six-month growth of real M1 remains solid by historical standards but has slipped back to its lowest since February.


M1 comprises physical cash and overnight deposits; a country breakdown is available for the latter. Lower six-month growth in real deposits in June reflected falls in both the core and periphery.


Real deposit growth declined in all four major economies in June while remaining consistent with economic expansion. Dispersion across the four is low by the standards of recent years, suggesting less economic “divergence”.

UK GDP rose by 0.6% in the second quarter (0.62% before rounding), in line with an upwardly-revised consensus forecast but below a long-standing 0.8-0.9% projection here.

As suggested in a post on Monday, services contributed more (0.48 percentage points) to quarterly growth than forecast by the consensus – the index of services rose by 0.2% in May after an upwardly-revised 0.3% April gain. This positive surprise, however, was offset by a weaker-than-expected contribution from construction: output grew by only 0.9% last quarter, adding 0.05 of a percentage point to GDP growth versus a forecast here of up to 0.2.

The construction figure, of course, is highly provisional and could well be revised up to show greater consistency with stronger orders and survey data. An official assumption that services output fell back by 0.1% in June is also questionable – the purchasing managers’ services activity index reached a 27-month high last month. The view here is that second-quarter growth will be upgraded by at least 0.1 percentage point as the revisions process unfolds over the remainder of 2013.

The “big picture” confirmed by today’s news is that an economic revival dating back to mid-2012 gathered pace last quarter. The improving trend is illustrated by the red bars in the chart, showing quarterly growth adjusted to exclude changes in North Sea oil and gas extraction and the effects of additional bank holidays and the Olympics. This underlying measure rose from zero in the second quarter of 2012 to 0.1% in the third quarter, then 0.2%, 0.2% and 0.6% last quarter.

Note that this pick-up pre-dated both the funding for lending scheme, which gained traction only in late 2012, and sterling weakness in early 2013 – factors cited by a respected commentator on BBC Radio Four’s Today programme this morning as key drivers of economic improvement. The view here, by contrast, is that the revival in activity from mid-2012 reflected a resumption of real (i.e. inflation-adjusted) money supply expansion from late 2011 – monetary trends lead the economy by about six months, according to the “monetarist” rule.

The real money turnaround since 2011 has been due to a combination of financial recuperation, a fall in inflation and – possibly – policy initiatives in the form of QE and FLS. As explained in a previous post, QE may have boosted the broad money supply by much less than claimed by the Bank of England, since official gilt-buying probably “crowded out” purchases by commercial banks, which have similar monetary effects.

Real money growth, on both broad and narrow measures, has remained healthy through May (June numbers will be released on 29 July), suggesting solid second-half economic performance.

Contrary to some expectations, nominal broad money trends have not slowed significantly since formal QE was suspended in late 2012, while narrow money has accelerated further. Credit leading indicators, meanwhile, have improved, suggesting that lending expansion will support monetary growth during the second half. There is, in other words, no case for additional monetary stimulus currently; such stimulus, indeed, could be counterproductive to the extent that it leaks into prices and causes a larger inflation drag on real money expansion.

Recent data confirm the monetarist forecast here of a recovery during 2013 in Eurozone economic activity, with improvement extending to peripheral countries in the second half.

Note, first, that Eurozone industrial output rose by 1.5% (not annualised) in the six months to May – the strongest six-month change since March 2011. The return to growth was predicted by a pick-up in real narrow money M1 during 2012.


Purchasing managers’ surveys have been improving gradually and the manufacturing / services composite output index finally broke above 50 in July, according to “flash” results released today. Historically, Eurozone GDP has grown with the index slightly below 50, so forthcoming figures could show expansion even in the second quarter. Manufacturing-only survey data confirm the pick-up in industrial activity, with orders at a 26-month high.


The positive message from monetary trends was reinforced by an easing of credit conditions in the first-quarter ECB bank lending survey, released in April, showing net percentages of banks tightening credit standards on loans to firms falling to levels historically consistent with economic expansion. Today’s second-quarter survey reports further improvement, particularly in expectations (the credit tightening balances are plotted inverted below).


“Good” news in the periphery includes a further recovery in July in PMI composite output and employment indices for the Eurozone ex. Germany / France, as well as the Bank of Spain’s estimate this week that GDP contracted by only 0.1% in the second quarter.

June monetary data released tomorrow will be important for assessing whether current promising trends will extend into 2014. 

The UK labour market is strengthening rapidly, a trend that could undermine the impact of any new MPC commitment to maintain current policy until the unemployment rate falls to a given level.

The MPC is widely expected to specify one or more “intermediate thresholds” for policy tightening next month in an effort to anchor the short end of the yield curve and bolster consumer and business confidence. A threshold based on the unemployment rate would have the advantage of simplicity and would mirror the approach of the Federal Reserve, which has committed to maintaining current official rates at least until the unemployment rate falls to 6.5%, providing that inflation and inflation expectations remain contained.

The Fed has set its threshold 2.1 percentage points above the jobless rate low of 4.4% reached in 2006-07, judging this margin sufficient to exclude the possibility of unemployment falling to an inflationary level (i.e. to below the “NAIRU”, or non-accelerating-inflation rate of unemployment). The UK unemployment rate troughed at 4.7% in 2004-05 so an equivalent approach would involve setting the threshold at 6.8%, or 6.75% rounding to the nearest 0.25 percentage point.

The unemployment rate was 7.8% over March-May, or 7.77% before rounding. As explained below, it is likely to fall significantly over the remainder of 2013 and, if the trend is sustained, could reach 6.75% in mid-2014. Since markets do not currently expect an official rate rise until 2015, this suggests that a threshold set at 6.75% would have no beneficial impact and could even prove counterproductive, by sharpening investor focus on better-than-forecast labour market outcomes.

The arithmetic of this scenario is as follows. Vacancies lead employee numbers and rose by 7% over March-May from six months earlier. Historically, such an increase has been consistent with employee growth of about 1% over six months, or 2% annualised – see first chart. A 2% rate of expansion would create 590,000 additional employees by mid-2014 (i.e. over the 14 months from March-May 2013 to May-July 2014).

Total employment would probably rise by slightly less because some of the additional employees would be drawn from the currently self-employed. Suppose that total employment increases by 550,000 by mid-2014.

Unemployment also reflects expansion of the labour force (i.e. those in or actively seeking work). Labour force growth has averaged 0.6% over the last 40 years. This rate of increase would result in a 230,000 rise by mid-2014. Combined with a 550,000 increase in employment, this would imply a fall in unemployment from 2.505 million currently to 2.185 million, or 6.7% of the labour force.

Unemployment pessimists argue that any decline will be slowed by a return of “economically inactive” people to the labour force. At 22.5%, however, the inactivity rate is currently low by historical standards – second chart. The rise in inactivity in 2009-10 was surprisingly small compared with previous recessions and has been more than reversed subsequently. A further consideration is that working-age population growth has slowed – to only 0.1% in the year to March-May. Assumed labour force expansion of 0.6% annualised, therefore, seems reasonable.

The plausibility of the above scenario is supported by the latest data for the more timely claimant-count unemployment measure – jobless claims dropped 21,000 in June, close to the 23,000 average monthly decline needed for labour force survey unemployment to fall to 2.185 million by mid-2014.

UK GDP is still expected here to have risen by 0.8-0.9% in the second quarter versus an upwardly-revised consensus forecast of 0.6%.

The hard data in hand are April / May output for the industrial and construction sectors, accounting for 14% and 6% of GDP respectively, and an April reading for services, with a 79% weighting. If it is assumed that output in the three sectors is unchanged at its latest published level, and there are no revisions to earlier data, GDP would rise by 0.5%. The consensus estimate, in other words, assumes little further growth later in the second quarter.

The expectation here, however, is that services output, in particular, will have registered further solid expansion. Supportive evidence includes:

• Retail sales volume in May / June was up 2.2% from April. Retail trade has a 7% weighting in the index of services, implying a 0.15% boost to output relative to April.

• Turnover in private non-financial services excluding retail / wholesale trade surged by 9.3% in value terms in May from a year earlier. This series is ignored by the consensus but is an important input to services output; the strength of the year-on-year gain suggests a significant positive contribution to the output change between April and May.

• Business surveys of services have been uniformly optimistic; the purchasing managers’ activity index, for example, reached a 27-month high in June.

A rise of 0.5% in services output in May / June compared with April is realistic on the basis of this evidence and would be consistent with a quarterly GDP rise of 0.8% (i.e. maintaining the other assumptions above).

Monetary trends and leading indicators have signalled respectable global growth through late 2013 – see previous post. The measure of global real money supply expansion tracked here, however, slowed significantly in June, based on data for countries with a weighting of about 60% in the aggregate. Allowing for the usual half-year lead, this suggests that economic momentum will fade at end-2013.

Specifically, six-month growth in real narrow money in the G7 and emerging E7 economies fell from 3.8% (not annualised) in May to an estimated 3.1% in June, which, if confirmed, would be the slowest since July 2012 – see first chart. (Narrow money is more closely related to economic transactions than broad money, which contains a significant savings element; this is confirmed by its superior leading indicator properties.)

The second chart decomposes real money growth into nominal monetary expansion and inflation. A rebound in inflation contributed significantly to the June real money slowdown, although nominal growth also eased.

The inflation drag on real money may intensify. The third chart compares changes in consumer and commodity prices. Commodities have driven the major fluctuations in inflation in recent years. Inflation undershot the relationship in early 2013, giving a temporary lift to real money expansion, but has since reconverged with the “predicted” level. Unless commodity prices show renewed weakness, the suggestion is that inflation will increase further.

The fourth chart shows real money growth for countries that have released June data. The fall in the global measure is mainly due to similar declines in the US and China. Chinese weakness may partly reflect last month’s short-lived money market squeeze; July figures will be awaited before concluding that monetary trends have deteriorated. The final June global reading will depend importantly on Eurozone data scheduled for release on Thursday.

The judgement here is that the monetary information in hand is insufficient to warrant turning more cautious on economic and market prospects. Even with the June decline, real money growth remains comfortably above industrial output expansion, suggesting “excess” liquidity that may support asset prices – see first chart. Relatedly, global fund manager cash balances are elevated, according to the latest Merrill Lynch survey; high cash is usually a signal of near-term market strength rather than weakness.