The MSCI Japan index fell by 9.1% in US dollar terms between end-2013 and yesterday, while the All-Countries World index was unchanged (-0.1%). Japanese stocks have been underperforming since July, when real narrow money growth started to diverge negatively from global trends. Based on March monetary data released today, Japanese real narrow money* is estimated to have risen by 1.3%, or 2.7% annualised, over the last six months. This compares with a six-month gain of 3.8%, or 7.8% annualised, in the global aggregate monitored here in February (the latest available month).

Why has real narrow money growth remained weak despite the Bank of Japan’s QE blitz? There are three reasons. First, QE has had a disappointing impact on the broad money supply. Annual M3 growth has risen from 2.5% in March 2013, just before the QE expansion, to 2.9% last month. As suggested in a post a year ago, the BoJ’s bond purchases have been significantly offset by selling by banks, whose demand for liquid securities has fallen as QE has expanded their reserves. Over 2013 as a whole, the BoJ bought ¥67 trillion of public sector securities, while depository corporations sold ¥32 trillion, according to the flow of funds accounts – see first chart. Total banking system purchases, therefore, were ¥35 trillion – in the middle of the range of recent years and equivalent to a modest 3.1% of M3.

Secondly, the minor uplift to nominal money growth from expanded QE has been outweighed by a pick-up in inflation, driven mainly by yen weakness that was a subsidiary aim of the policy. Real money expansion on both broad and narrow measures is now significantly lower than was achieved in 2012 / early 2013 under the previous BoJ leadership, which pursued less aggressive QE but did not promote yen depreciation – second chart. Inflation will be mechanically boosted by the recent sales tax increase but the yen impact is fading.

Thirdly, narrow money trends are largely demand-driven, reflecting the needs of consumers and firms to hold immediately-available liquidity for use in future economic and financial transactions. Even if QE were to succeed in delivering a large boost to broad money, there is no guarantee that this increase would feed through to a higher level of transactions, as opposed to being “hoarded”. The failure of narrow money to surge suggests that “Abenomics” has yet to have the desired stimulatory impact on consumer / business behaviour.

On current monetary readings, Japanese economic growth is likely to remain lacklustre, while equities hold little relative attraction. The hope is that real money trends will improve later in 2014 as bank lending continues to strengthen, inflation subsides as the yen / tax boost fades and consumer / business confidence rebounds, possibly in conjunction with a stronger global economy. Such a scenario could be disrupted if current disappointing news prompts further BoJ fireworks and another inflation-boosting fall in the exchange rate.

*M1 deflated by consumer prices, seasonally adjusted. March CPI estimated from Tokyo data.

Global* short- and longer-term leading indicators** support the forecast here that six-month industrial output growth will pick up from a trough to be reached in the late spring.

The two indicators have led growth turning points by 2-3 months and 4-5 months respectively in recent years. The longer-term measure peaked in July-August 2013 while the short indicator topped in August-September. Global six-month industrial output growth reached a maximum in November-December, falling again in February, based on data covering 75% of the aggregate monitored here – see first chart.

The longer-term indicator, however, recovered in February while the short measure stabilised. This suggests that output growth will decline further to a trough in May before rebounding into the summer.

The rise in the longer-term leading indicator confirms an earlier positive signal from global real narrow money expansion, which bottomed in November 2013 and has picked up strongly in early 2014 – second chart and previous post. The summer growth rebound, in other words, is likely to be significant and sustained into late 2014.

*”Global” = G7 developed economies and E7 emerging economies.
**The indicators are calculated by transforming and combining the OECD’s country leading indices. The message from these derived indicators often disagrees with the OECD’s interpretation of its own data.

The first-quarter British Chambers of Commerce survey supports the assessment here that recent strong growth has exhausted spare capacity and is starting to put upward pressure on inflation, implying a significant probability that the Bank of England will be forced to raise official rates before year-end.

The percentage of services firms operating at full capacity rose further last quarter, to the second highest level in the survey’s 25-year history – see first chart. The manufacturing percentage fell slightly but is also near the top of its historical range.

The percentage of services firms planning to raise prices rose for a third quarter to its highest since the first quarter of 2011 – second chart. The manufacturing percentage declined, probably reflecting recent sterling strength, but remains above average.

In other news today, industrial output rose by a stronger-than-expected 0.9% in February, further increasing the probability that the preliminary estimate of first-quarter GDP growth released later this month will exceed the Bank of England’s 0.8% assumption in the February Inflation Report – see previous post.