Investors are concerned about weakness in the global economy and China in particular. Monetary trends are giving a reassuring message, suggesting that economic growth will revive into early 2016 before slowing again later next year.

The monetary measure used for forecasting here is the six-month change in global real narrow money, with “global” defined as the G7 plus seven large emerging economies (the “E7”)*. Statistical testing shows that this leads the six-month change in industrial output by nine months on average. Turning points in industrial output growth, meanwhile, usually coincide with those in GDP growth.

The six-month change in real narrow money turned negative before the six global recessions since the 1960s.

Real narrow money growth has moderated from a peak in February but rose slightly in August and remains solid by historical standards – see first chart. Its strength in early 2015 suggests that global activity news will improve near term but the uplift in growth may prove temporary, based on the more recent monetary slowdown.

Real broad money is giving a similar message to narrow money, though has an inferior historical record as a forecasting indicator of the economy.

The six-month change in industrial output appears to have remained negative in August, based on available data, but may have bottomed in June – first chart. If the monetary forecast is correct, it should soon return to positive territory.

Real narrow money is very far from contracting, suggesting a low risk of a recession. However, the low level of interest rates may be boosting the “trend” growth rate of narrow money, implying that a significant slowdown would be a sufficient signal for a recession. To attempt to gauge this possibility, a forecasting indicator was constructed allowing for divergent trends of real narrow money and industrial output growth, and also applying the average nine-month lead. A second indicator was calculated additionally incorporating the slope of the G7 yield curve, which – like real narrow money – has a good record of signalling recessions. These adjusted real money growth indicators are giving a reassuring message – second chart.

The relative stability of global real narrow money growth conceals some significant changes at the country level. As discussed in a previous post, real narrow money has slowed sharply in the US over the last six months while rebounding strongly in China. These and other changes have resulted in E7 growth moving above the G7 level for the first time since June 2013 – third chart.

Is this a positive signal for emerging market equities? As noted in another recent post, a “simplistic strategy that would have worked well would have been to invest in emerging markets when E7 six-month real money growth was above 4% and had not fallen by more than 2 percentage points over the prior six months but revert to developed markets if either of these conditions was no longer met”. August E7 growth was an estimated 3.0%**.

*The G7 only was used in analysis before 2005. Narrow money = currency in circulation plus demand deposits and close substitutes; precise definition varies by country. Real = deflated by consumer prices, seasonally adjusted. “E7” defined here as BRIC plus Korea, Mexico and Taiwan.
**August data available for all countries except Korea.

Broad liquidity holdings of UK households and non-financial firms are growing at the fastest pace since the 2008-09 recession, supporting optimism about economic prospects and strengthening the case for an early interest rate rise.

The Bank of England’s preferred broad money aggregate, M4 excluding money holdings of “intermediate other financial corporations” (M4ex), rose by an annual 3.9% in August, in line with the average since the start of 2014 – see first chart. Its growth, however, has been depressed by two factors unlikely to be of economic significance. First, money holdings of financial corporations have fallen by 4.3% over the past year, cutting M4ex growth by an arithmetical 0.6 percentage points. This reflects a decline in bank deposits held by fund managers* and securities dealers, and has little implication for spending in the economy.**

This suggests focusing on M4 holdings of households and non-financial firms, or “non-financial M4”, rather than M4ex. Annual growth of non-financial M4 was 5.3% in August, the fastest since July 2013 – first chart.

Secondly, the annual rise in household M4 has been lowered by large-scale switching into National Savings products. The 12-month inflow to NS was a record £21.8 billion in August, mainly reflecting heavy buying of high-interest pensioner bonds on offer from January until one week after the May general election. Such bonds, and other NS products, would be included in M4 if issued by a bank rather than the government. This argues for adding together non-financial M4 and outstanding NS when judging the broad liquidity position of households and non-financial firms. This expanded measure grew by an annual 6.3% in August, the fastest since June 2008 and well above an average of 3.7% over 2010-14 – first chart.

The positive message from broad liquidity is reinforced by still-solid narrow money trends. Non-financial M1, comprising notes / coin and sight deposits of households and non-financial firms, grew by an annual 7.6% in August – second chart.

Bank credit expansion is lagging money growth – the usual cyclical pattern – but is firming, with forward-looking indicators positive. M4 lending to households and non-financial firms rose by an annual 1.9% in August, the fastest since May 2009 – second chart. Mortgage approvals totalled £19.6 billion in August, the highest since April 2008. Excluding remortgages, approvals were £12.9 billion, almost matching a peak of £13.0 billion in January 2014 associated with a rush to beat new tougher mortgage rules. Meanwhile, sterling unused credit facilities – another leading indicator – grew by an annual 4.1% in August, with a notable pick-up in recent months***.

*Insurance companies / pension funds, investment / unit trusts and other fund managers.
**The fall may also be of limited significance for asset prices, since it may have been offset by a rise in financial institutions’ holdings of other liquid assets: the outstanding stock of DMO repos and Treasury bills increased substantially in the year to August.
***16.1% annualised rise over latest three months.