Global equities and bank reserves held at the Fed, Bank of Japan (BOJ) and ECB have trended higher since the 2008-09 crisis / recession – see first chart. This has prompted claims that central bank liquidity creation has been the key driver of markets.

The view here is that the twin upward trends are largely coincidental. There was no correlation between equities and reserves before the crisis. Liquidity availability for markets depends on the relative growth rates of the real (inflation-adjusted) money stock and output. Global real narrow money has mostly risen faster than industrial output since 2008, explaining equity gains. The relative strength of real money growth, of course, partly reflects central bank policies but is only loosely related to rising reserves.

The largest fall in equities since 2009 occurred in 2011: the MSCI All-Country World Index in US dollars suffered a 23.9% peak-to-trough decline over May-October. This followed a period in 2010 when annual growth of G7 real narrow money was beneath that of industrial output – second chart. By contrast, G3 bank reserves were rising strongly before the 2011 correction.

The G7 real money / output growth gap remains significantly positive and is unlikely to close before end-2015. G3 reserves, meanwhile, will continue to trend higher as the BOJ and ECB proceed with QE programmes – third chart. Both indicators, therefore, suggest further near-term upside for equities but “excess” money growth is more likely to warn of the next bout of weakness.

Chinese economic growth has revived modestly in line with an earlier recovery in real money expansion. The latest monetary statistics suggest further improvement, although additional June details are needed to confirm this assessment.

GDP is officially estimated to have risen by 1.7% in the second quarter, up from 1.4% in the first. Annual growth was unchanged at 7.0%, implying that the government remains exactly on track to meet its full-year forecast of about 7%.

The monthly industrial output numbers* are regarded here as a more accurate reflection of economic reality. Six-month output growth reached a six-year low of 1.8% in March but has recovered to 2.6% in June (5.3% annualised). This is still well below an average of 4.4% (9.1% annualised) over 2012-14 – see first chart.

Economic weakness in early 2015 was signalled by a contraction of real narrow money during the second half of 2014. As previously explained, narrow money is best measured by “true” M1, which adds household demand deposits to the official M1 measure. The six-month change in real true M1 bottomed in December, recovering modestly in early 2015, consistent with a revival in economic momentum around mid-year.

Headline money numbers for June suggest that the economic pick-up will be sustained, with six-month real growth of official M1 and the broader M2 measure rising further. The assessment here, however, will rely on true M1, a June reading for which is not yet available**.

Another notable feature of today’s batch of activity data was a further recovery in housing sales, which, if sustained, should lift prices and housebuilding activity during the second half, with positive implications for industrial output – second chart.

*World Bank seasonally adjusted level series.
**Household deposit data are typically released one week after the headline money numbers.