Recent posts have suggested that the global economy will expand solidly during the second half of 2013 although a slowdown in real money expansion in June warns that momentum could fade at year-end – see here and here.

Strong near-term performance may be reflected in better-than-expected labour market outcomes. The first chart shows the G7 unemployment rate together with a weighted average of consumer survey responses about employment / unemployment in the US, Japan, Eurozone and the UK – a fall indicates improving conditions and vice versa. This indicator has accelerated lower recently, suggesting that unemployment is about to fall significantly.

UK consumers are particularly upbeat, with the net percentage expecting unemployment to rise over the next 12 months at its lowest since 2005 – second chart. This supports the forecast here that the unemployment rate will fall to 6.5-7% by mid-2014, from a current 7.8%. The MPC, in other words, may need to set any unemployment rate threshold well below this range if it wishes to convince markets that rock-bottom rates will be maintained until 2015-16.

A measure of the rental yield on residential property derived from the national accounts rose further above its long-run average in the first quarter of 2013, suggesting that house prices are becoming increasingly undervalued relative to rents.

The national accounts yield measure is calculated by dividing the sum of actual rental payments and imputed rents of owner-occupiers by the value of the housing stock. The yield is calculated on a trailing 12-month basis, i.e. its first-quarter value equals rents in the year to end-March divided by the end-March value of the housing stock.

The rental yield has averaged 4.26%* since 1965, moving well below this level during the house price bubbles of the early 1970s, late 1980s and 2000s associated with monetary laxity overseen respectively by Lords Barber, Lawson and King.

The yield reached a low of 3.34% in the third quarter of 2007, suggesting that house prices were then overvalued by 28% relative to rents (i.e. the percentage deviation of 4.26 from 3.34). It has since risen steadily, reflecting a fall in prices in 2008-09 and sustained solid growth in rents.

The yield was an estimated** 4.89% at the end of the first quarter, consistent with house price undervaluation of 13%.

Houses remain expensive in terms of earnings but bubbles are characterised additionally by an overshoot of prices relative to rents, as rose-tinted perceptions of capital gains potential distort assessments of the merits of owning rather than renting. Government policies designed to stimulate home-buying are ill-advised but current prices are far from bubble territory.

*The yield series has shifted higher as a result of a recent change in national accounts methodology; specifically, imputed rents are now measured on a gross basis before subtracting estimated repairs and maintenance costs.
**The value of the housing stock at end-March was estimated by linking a published end-December reading to the change in the official house price index between December and March.

UK real money growth has stabilised at a level suggesting solid second-half economic expansion.

The favoured broad and narrow aggregates here are non-financial M4 and M1, comprising holdings of households and private non-financial firms. These measures rose by 2.6% and 5.7% respectively in the six months to June, or 5.2% and 11.7% annualised. This represents significant real expansion since consumer prices rose by 1.0% after seasonal adjustment, or 2.1% annualised, over the same period – see first chart.

Following real contraction in 2011, non-financial M4 and M1 growth crossed above inflation at the start of 2012, signalling an economic recovery from mid-2012, allowing for the usual half-year lead.

Broad money growth remains modest by pre-crisis standards but is unlikely to be “too low” because the demand to hold money is being depressed by negative real deposit interest rates. It is the difference between the supply of money and the demand to hold it that determines whether economic activity / inflation will rise or fall.

Put differently, the MPC would guarantee an inflation overshoot if it were to commit to maintaining rock-bottom official rates until broad money expansion rose to an historically-normal rate of 7-8%*.

Much faster expansion of M1 than M4 is viewed here as evidence that households and firms are deploying monetary savings in the economy – funds have been moved from savings to current accounts to finance higher spending and financial investment. Such a shift has been encouraged by a further collapse in savings deposit rates over the last year, partly due to the funding for lending scheme. The M1 / M4 divergence, in other words, suggests a rise in the velocity of circulation.

Despite the suspension of formal QE last November, non-financial M4 rose at similar rates in the first half of 2013 and second half of 2012, i.e. 5.2% annualised versus 5.9%. This is consistent with the view here that QE had only a small positive impact on monetary growth. Broad money trends have been supported recently by a reduction in banks’ wholesale funding (i.e. net external and foreign currency borrowing and sterling non-deposit liabilities). For a given stock of sterling bank lending to the UK private and public sectors, a cut in such funding leads to a rise in M4.

Private-sector lending fell slightly in June but may expand in the second half – credit is usually a coincident or slightly lagging indicator of the economy. Arranged but unused sterling credit facilities rose by 4.4%, or 9.0% annualised, during the first half – second chart.

*Non-financial M4 grew at an average annual rate of 7.7% in the 10 years to December 2007.