Official data released this week confirm that the economy is growing robustly but were marginally disappointing from the perspective here. The rise in GDP in the second quarter was unrevised at 0.7%, versus an expected upgrade to 0.8%, although first-quarter growth was raised from 0.3% to 0.4%. Services output, meanwhile, increased by “only” 0.2% in July – a larger gain had been suggested by turnover data released last week. All these numbers, of course, remain highly provisional and will probably be revised higher, reflecting a tendency for official statisticians initially to underestimate activity when the economy is accelerating.

The data in hand indicate that GDP in July was 0.5% above the second-quarter level – see first chart. It is reasonable to pencil in monthly increases of 0.3% for August and September based on the strength of survey evidence, suggesting that the first estimate of third-quarter GDP to be released on 25 October will show quarterly growth of 0.8%. The Bank of England, for comparison, was projecting 0.7% expansion at the time of this month’s MPC meeting.

The run of buoyant survey evidence continued today with a further rise in the EU Commission’s UK consumer confidence measure to its highest level since 2005 – second chart. The net percentage of respondents expecting higher unemployment over the next 12 months fell to a 12-year low, consistent with other evidence of labour market improvement and supporting the forecast here of a faster-than-expected decline in the jobless rate – third chart.

Eurozone monetary trends are consistent with a continued but moderate economic recovery. Six-month growth in real narrow money, M1, was little changed at 2.6% (not annualised) in August – in line with its 20-year average. Excluding financial sector* holdings, real M1 expansion is running at a higher level and improved last month – see first chart. As in the UK, the non-financial measure appears to perform slightly better as a leading indicator of the economy.

Broad money, M3, continues to lag M1, flatlining in real terms over the last six months, but its forecasting performance has been patchy – it failed, for example, to signal the 2008-09 recession. Current weakness should be discounted because the savings demand to hold money is being depressed by low deposit interest rates. 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.

The second chart shows growth by country of real overnight deposits (no country breakdown is available for the cash component of M1). Last year’s divergence between Germany and France has closed, signalling similar economic prospects. Growth remains strongest in Greece and Ireland** but has fallen back in Portugal and Italy – this accords with a rise in Banca d’Italia’s Target2 deficit in August, suggesting that capital reflux to the country has stopped. Dutch relative weakness, meanwhile, persists.

*Including the European Stability Mechanism.
**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.

The economic strategy of the Abe government and its Bank of Japan (BoJ) placemen is to employ monetary policy stimulus to push growth up to “escape velocity” before hiking the consumption tax to begin closing the huge budget deficit. Current monetary trends, however, suggest that the tax rise will hit before the economy has reached orbit.

The government will reportedly announce next week that it is proceeding with plans to raise the consumption tax from 5% to 8% in April 2014. A complementary “stimulus” package is expected to be unveiled but will be a fraction of the size of the tax grab.

The strategy assumes that the economy will be expanding strongly next spring under the influence of the BoJ’s ultra-aggressive QE programme. While money growth rates have firmed, however, the surge predicted by optimists has failed to materialise – see first chart. This is partly because the money supply impact of the BoJ’s bond purchases has been offset by stepped-up selling by banks* – a possibility envisaged in a previous post.

The rise in nominal monetary expansion, moreover, has been more than matched by faster consumer price inflation. Six-month growth in real narrow money M1, therefore, is no higher than a year ago and has retreated recently – second chart. This suggests that the economy will be losing, not gaining, momentum in spring 2014, allowing for the typical half-year lag between real money shifts and demand / activity.

The monetarist perspective here is that raising indirect taxes inflicts more short-term economic damage than other forms of fiscal tightening, because there is an immediate, significant impact on the price level, resulting in a squeeze on real money holdings. UK economic growth withstood fiscal restraint in 2010 but ground to a halt after standard-rate VAT was raised from 17.5% to 20% in January 2011. The last – smaller – hike in Japan’s consumption tax in 1997, of course, kicked off a severe recession (extended, admittedly, by the Asian / LTCM crises).

The latest six-month rises in M1 and consumer prices were 2.8% and 0.8% respectively, giving a real M1 increase of 2.0% (all numbers are seasonally adjusted, not annualised). The tax hike will boost the CPI by about 2.5%, suggesting that six-month inflation will climb temporarily to about 3% next spring. Unless nominal growth rises, therefore, the six-month change in real M1 will fall to zero or turn negative – unlikely to be compatible with continued economic expansion.

Other money measures, and bank lending, are growing more slowly than M1, implying a higher risk of real contraction.

It is possible that QE is operating with a lag and will push money growth rates significantly higher before the tax hike hits. The view here is currently agnostic bordering on sceptical; increased caution on Japan’s economic and equity market prospects will be warranted if monetary acceleration fails to materialise by end-2013.

*The BoJ’s holdings of government bonds and bills rose by ¥31 trillion between end-March and end-July; banks reduced their holdings of central government securities by ¥24 trillion over the same period.

Services turnover figures for July support hopes that GDP will expand by about 1% in the third quarter, consistent with “monetarist” optimism about economic prospects.

The turnover figures are neglected by the market but are an important input to the calculation of services output, a July number for which will be released on Friday. The turnover survey omits the government, retail and financial sectors so covers about 55% of services output. A further complication is that the numbers are in value rather than volume terms and are not seasonally or working-day adjusted.

The chart compares quarterly changes in seasonally-adjusted output volume and turnover value*, with a third-quarter estimate of the latter included based on the July survey. The suggestion is that output in the relevant sectors is on course to post a bumper rise. On conservative assumptions about government, financial services and retail trade*, services growth could exceed 1% this quarter, following 0.6% in the second quarter.

Already-released industry and construction data indicate that the two sectors will contribute about 0.25 percentage points (pp) to third-quarter GDP expansion if July output levels are maintained. A 1% services rise would add a further 0.75 pp for a total GDP gain of about 1%.

*Seasonally adjusted in Datastream.
*Retail trade accounts for 7% of services output. Sales volume in July / August was 1.5% above its second-quarter level, suggesting a 0.1 percentage point contribution to services growth.

Some commentators have suggested that a decision by the Fed to begin “tapering” bond purchases would have been a mistake on a par with the central bank’s policy tightening in 1936-37 – viewed by many as a key driver of the 1937-38 “Roosevelt recession”. Such claims are fantastical.

The Fed doubled reserve requirements in 1936-37, cutting the effective supply of liquidity to banks by one-third, according to the adjusted reserves series compiled by the St. Louis Fed. Reducing bond purchases, of course, merely slows the rate of increase of reserves rather than yielding a decline. A cut in bond buying to $75 billion per month in the fourth quarter, $50 billion in the first quarter of 2014 and $25 billion in the second quarter would still result in reserves swelling by nearly 20% by mid-2014.

Worries about QE wind-down appear even less grounded from a global perspective. Combined bank reserves in the US, Japan and Euroland will plausibly rise by about 40% to $5 trillion by the end of 2014, assuming that Fed bond purchases slow to zero during the first half, the Bank of Japan adheres to current plans and ECB liquidity actions are broadly neutral – see chart. Put differently, of a $3.4 trillion projected rise in reserves between the start of 2009 and end-2014, two-fifths has yet to occur.

The Fed’s decision to maintain bond buying at $85 billion per month rather than cutting to $75 billion, as was widely expected, will have a tiny impact on global liquidity but has increased policy uncertainty and underscored the uselessness of central bank “guidance”; the soggy considered response of equities appears warranted.