The US economy performed robustly over the spring and summer. GDP growth, admittedly, fell from 3.9% at an annualised rate in the second quarter to 1.5% in the third, according to preliminary data. This slowdown, however, largely reflected a decline in stockbuilding: final sales rose by an annualised 3.0% last quarter. GDP growth averaged a solid 2.7% across the two quarters.

Economic health in mid-2015 had been signalled by narrow money trends at end-2014. Six-month growth of real narrow money fell sharply in summer 2014, warning of a loss of momentum in early 2015, allowing for the usual lag. It rebounded strongly from October, however, peaking in February 2015 – see first chart. The message was that the poor start to the year – exacerbated by bad weather – represented a temporary soft patch, with news likely to improve significantly later in 2015.

The consensus expects growth to remain strong by the standards of the upswing to date. The mean forecast for annual GDP expansion in 2016 is 2.6%, according to Consensus Economics, with the IMF projecting 2.8%. This compares with average growth of only 2.1% annualised from the recession trough in the second quarter of 2009 through the third quarter of 2015.

This optimism is questionable, for two reasons. First, real narrow money has slowed again since the spring, with six-month growth in August / September the lowest since January 2010, and weekly data suggesting no recovery in October. Real M2 and bank lending are holding up better but have also lost momentum – first chart.

Secondly, stock changes are likely to be a further drag on GDP growth over coming quarters. The 3-5 year Kitchin stockbuilding cycle last bottomed in 2012, so another trough is due in 2016 or 2017. As previously discussed, the ratio of non-farm inventories to final sales of goods and structures is usually above its long-run downward trend at the peak of the cycle, and below it at the trough. It remained elevated at end-September, despite the fall in stockbuilding last quarter – second chart.

Strengthening non-US real narrow money growth – particularly in China – suggests that the global economy can regain momentum even if the US slows. Economic “rebalancing” from the US to the rest of the world would be favourable for markets, supporting equity earnings while allowing the Fed to go slow on rate rises. The current monetary evidence supports this benign scenario but further US narrow money weakness, or a relapse in China or the Eurozone, would warrant a reassessment.

 

Annual growth of broad liquidity held by UK households and private non-financial corporations (PNFCs) rose from 6.1% in August to 6.2% in September, the fastest since June 2008. Corporate money, in particular, is surging, suggesting strong prospects for business spending. If the recent stability of the velocity of broad liquidity were to persist, sustained growth at the current pace would cause inflation to overshoot the 2% target over the medium term.

The strengthening of liquidity trends is underappreciated because most commentary focuses on the Bank of England’s M4ex* broad money aggregate, annual growth of which has remained at about 4% (3.9% in September) – see first chart. The increase in M4ex over the past 12 months, however, was depressed by 1) older savers switching out of bank deposits into National Savings (NS) pensioner bonds and 2) a fall in financial sector money. Neither development is of economic significance**.

A better guide to the availability of liquidity to finance private sector spending at present is the sum of M4 money held by households and PNFCs – i.e. “non-financial M4” – and outstanding NS. Of the 2.3 percentage point gap between the annual growth rates of this aggregate (6.2%) and M4ex (3.9%), about two-thirds is due to the NS effect and one-third to falling financial sector deposits.

The velocity of circulation of this liquidity measure has been broadly stable in recent years – see previous post. If velocity were to continue to move sideways, sustained 6% liquidity growth would be reflected, in time, in an equal rate of increase of national income. This, in turn, would imply inflation of about 3.5%, assuming 2.5% trend output expansion.

Annual growth of both corporate and household liquidity has risen over the past year but the former is much stronger – 12.4% versus 4.8%. Significant changes in corporate liquidity growth have foreshadowed economic fluctuations in recent years. Corporate liquidity contracted before the 2008-09 recession and the 2011-12 “double-dip” scare, but rebounded sharply in 2012 ahead of the positive GDP growth surprise in 2013 – second chart. The further increase in liquidity expansion this year casts doubt on the consensus forecast of slower GDP growth in 2016 than 2015.

The suggestion that monetary conditions have loosened, requiring an early policy response, is supported by still-robust expansion of narrow money, as measured by non-financial M1, and a continued pick-up in bank lending to households and PNFCs, annual growth of which reached 2.2% last month, the fastest since April 2009 – third chart. Leading indicators suggest further credit acceleration: mortgage approvals reached another post-recession high in value terms last month, while annual growth of arranged but undrawn credit facilities rose to 6.0%, the fastest since December 2004.

*M4ex = M4 excluding holdings of “intermediate other financial corporations”.
**The £11 billion fall in financial sector M4 in the year to September may partly reflect a switch from bank deposits to other liquid instruments: private-sector holdings of Treasury bills and other central government debt (mainly short-term repo borrowing by the Debt Management Office) rose by £8 billion over the same period.

Eurozone monetary trends remain consistent with solid economic growth but there has been no further pick-up since QE began in March. This suggests that 1) further monetary policy easing is unwarranted and 2) more QE would, in any case, be ineffective.

The best monetary measure for forecasting purposes, according to ECB research, is real (i.e. inflation-adjusted) non-financial M1, comprising holdings of currency and overnight deposits by households and non-financial corporations. Six-month growth of this measure surged between spring 2014 and early 2015, signalling improving economic prospects – see first chart. GDP growth moved up from 0.7% at an annualised rate in the first three quarters of 2014 to 1.6% in the fourth quarter and 1.8% in the first half of 2015. Survey evidence suggests a similar pace in the third quarter. This appears to represent above-trend expansion, judging from an accompanying decline in the unemployment rate and a rise in manufacturing capacity utilisation.

Six-month growth of real non-financial M1 has retreated from a peak reached in January 2015 but has remained robust and rebounded in September. Growth in real non-financial M3 has followed a similar pattern. The message is that GDP expansion should continue at around its recent pace through early 2016, at least.

QE has not resulted in a further rise in money growth because the positive impact of asset purchases has been neutralised by reduced buying of government bonds by banks and an external capital outflow. This mirrors experience in the US, UK and Japan, discussed in previous posts. The lack of monetary impact suggests that the economic benefits of QE have been much smaller than its promoters claim.

Country-level data show a recent slowdown in real M1 deposits in the core countries but an offsetting pick-up in the periphery – second chart. Spain moved back to the top of the big four ranking last month, with Italy also rebounding; growth has cooled but remains solid in France and Germany – third chart.