UK monetary trends are signalling strong second-half economic expansion but hint that growth will moderate, while remaining solid, around year-end.

The broad and narrow monetary aggregates favoured here are non-financial M4 and M1, comprising holdings of the household sector and private non-financial corporations (PNFCs). Annual growth in the M4 measure was little changed at 5.4% in July, versus a recent peak of 5.6% in April, while M1 expansion rose further to 10.8% – the highest since August 2004.

Future economic activity, however, is related to real (i.e. inflation-adjusted) rather than nominal monetary expansion. The forecasting approach here, moreover, focuses on six-month rather than annual growth, reflecting the typical six-month lag between monetary changes and their effect on the economy.

The latest six-month changes in real non-financial M4 and M1 are respectable and strong respectively but both have moderated from peaks in April – see first chart. This suggests that economic growth will peak in late 2013, slowing slightly in early 2014.

The recent moderation in real money supply trends reflects a combination of lower nominal expansion and slightly faster price rises.

The consensus is likely to focus on a rise in bank lending in July – the stock of lending to households and PNFCs increased by £4.1 billion, or 0.3%, the most since February 2009. Credit is, at best, a coincident indicator of the economy so this simply confirms the positive message from other recent data. The lending recovery, however, may reinforce current "feel-good" sentiment.

Nominal rather than real money expansion is relevant for assessing inflation prospects. The rise in annual non-financial M4 growth between August 2011 and April 2013, with little change more recently, suggests that core inflation will trend higher through mid-2015, allowing for an average two-year lag between monetary changes and prices – see second chart and previous post for details.

In other UK news today, the EU Commission consumer confidence measure, based on a survey conducted by GfK, continued to surge higher in August and is now well above its long-run average – third chart. The net percentage of respondents expecting labour market weakness fell to its lowest level since March 2005, supporting the forecast here of a rapid decline in the unemployment rate.

Business surveys indicate a pick-up in world trade, consistent with the forecast here of solid global economic expansion through late 2013.

The chart shows two-quarter growth in OECD export plus import volumes together with trade-related responses in the US ISM and German Ifo manufacturing surveys. The surveys appear to be a coincident indicator of trade volumes but are useful because they are published with a much shorter delay. The suggestion is that volume growth has returned to a normal level by historical standards following weakness in late 2012 / early 2013.

Stronger developed-world import demand should support growth in emerging economies near term, helping to offset the negative impact of recent tighter financial market conditions.

Eurozone monetary statistics for July were encouraging from the perspective here, showing narrow money M1 rising by 1.0% on the month, more than reversing a 0.5% fall in June. Six-month real (i.e. inflation-adjusted) growth remains robust at 2.8% (not annualised), consistent with the current economic recovery extending into early 2014 (at least) – see first chart.

Broad money M3 continues to lag M1 significantly – it rose by only 0.1% in real terms in the six months to July. The broad measure has, however, underperformed M1 as a leading indicator historically and should be discounted now because the low level of bank deposit rates is depressing the savings demand to hold money. M1 – comprising physical cash and overnight deposits – is a better measure of money held for transactions purposes, explaining its relationship with future spending and activity.

“Creditists” will highlight a continued contraction of bank lending to the private sector as a reason for pessimism. Credit trends, however, influence economic prospects only to the extent that they affect monetary growth. Credit weakness has not caused broad money to contract because of offsetting positive contributions from external flows (partly reflecting the Eurozone’s large current account surplus), lending to governments and a reduction in banks’ longer-term (i.e. non-money) liabilities – second chart.

Modest broad money growth coupled with a shift of funds out of notice and savings accounts in response to low interest rates has resulted in robust M1 expansion and an associated economic revival that creditists and Keynesians failed to predict.

The ECB publishes a country breakdown of overnight deposits. Six-month real deposit growth remains similar in the core and periphery groupings – third chart. There are, however, notable divergences at the country level: Dutch trends suggest a continued recession while the six-month change is strongest, amazingly, in Greece – fourth chart*. The latest German and French readings are the same and higher than in Italy and Spain, where growth has eased.

*Note: the Irish series in the chart has been adjusted to exclude the impact of the liquidation of the Irish Bank Resolution Corporation in March 2013.