Global monetary trends have been suggesting faster economic growth in the second half of 2015 – see previous post. May business surveys are consistent with this scenario: a weighted average of G7 manufacturing purchasing managers’ new orders indices rose significantly, with improvements in six of the seven countries (Germany being the exception) – see first chart.

The coming growth pick-up is at least partially discounted in markets, judging from recent divergent performance of global equities and government bonds, and relative strength of cyclical stocks. The key issues now are how long the upswing will last and whether it will give way to another slowdown in 2016.

Six-month growth of global real narrow money reached a peak in February – second chart. The lead time from real money to output has averaged eight months at the last three growth turning points, suggesting that economic momentum will top out around October.

Real money growth remained solid in April, consistent with little economic slowdown in late 2015. It is likely, however, to fall further as inflation continues to recover, assuming that commodity prices are stable at current levels – third chart.

A plausible scenario, therefore, is that strong second-half growth will give way to a loss of economic momentum in early 2016, following a real money slowdown this summer. The coming upswing, in other words, will prove to be another false down.

How could this be too pessimistic? One possibility is that nominal money growth will strengthen, offsetting the inflation drag on real money expansion. The most likely source of a rise in global money growth is China, where trends are showing signs of improvement and recent policy easing has yet to feed through – see previous post.

An alternative growth-bullish possibility is that money velocity will pick up, or at least fall at a slower rate. A rise in velocity has the same economic impact as an increase in real money. A measure of the velocity of G7 narrow money is far below its declining long-term trend, suggesting the potential for a rebound – fourth chart.

What could trigger such a turnaround? The surprising answer is a rise in US interest rates. Velocity has increased when the Fed has tightened historically – fifth chart. Correlation is not causation, but this suggests that Fed tightening initially results in a stronger economy as the velocity effect outweighs the (lagged) impact of higher rates. An early Fed move, perversely, may warrant greater near-term economic optimism.

UK monetary trends are stable and consistent with a near-term revival in economic growth after the recent mild slowdown.

The preferred narrow and broad aggregates here are M1 and M4 excluding money holdings of financial corporations*. Both measures rose by 0.5% in April, leaving six-month growth rates little changed at 3.1% and 2.1% respectively, or 6.3% and 4.2% annualised – see first chart.

Economic prospects are related to real rather than nominal money trends. Reflecting the impact of commodity price weakness and sterling strength on consumer prices, six-month growth of real non-financial M1 and M4 is higher than during the second half of 2014, supporting the expectation of faster economic expansion through late 2015 – second chart.

An inflation revival later in 2015 will squeeze real money growth unless nominal trends strengthen. The latter scenario, however, is plausible: deposit / lending rates have fallen further, “excess” liquidity in the Eurozone may be flowing into the UK and bank lending is firming. Foreign investors bought £26.8 billion of gilts over February-April following the ECB’s QE announcement in January, the largest three-month sum since December 2013. Six-month growth of bank lending to households and non-financial firms rose to 1.1% in April, or 2.2% annualised, the fastest since December 2008 – first chart.

*M1 comprises notes / coin and sight deposits, with M4 adding in other deposits, repos and short-maturity bank paper. Money holdings of financial corporations are volatile and less relevant for judging near-term economic prospects.

The new orders component of the Chinese official manufacturing purchasing managers’ survey edged higher in May, and by more when account is taken of residual seasonality in the published series. This is consistent with a recent improvement in equity analysts’ earnings revisions noted in a previous post and suggests a near-term recovery in industrial output growth – see first chart.

The input prices component of the survey, meanwhile, rose to its highest level since July 2014, signalling a slowdown in producer price deflation – second chart.

Narrow money trends have been predicting a modest economic growth revival: the average level of six-month expansion of real “true” M1* so far this year has been higher than in the second half of 2014, although monthly data have been volatile and the latest reading was still subdued – third chart and previous post. Real M1 needs to strengthen significantly further to suggest that recent policy stimulus has been sufficient to return economic growth to target. (May money numbers are expected to be released over 10-15 June.)

*True M1 includes household demand deposits, which are excluded from the official measure.