Eurozone January money and credit numbers were solid, signalling that the monetary backdrop remains growth-supportive and anti-deflationary. The ECB risks disrupting these conditions by pushing rates further into negative territory. Economic sluggishness reflects a combination of global weakness, heightened uncertainty and slow trend growth partly due to lack of reform. The ECB should stand pat unless money trends soften. If further easing turns out to be required, extending QE to bank bonds would be the best option.

The headline M3 and M1 aggregates bounced back from softness in December to rise by 0.7% and 1.0% respectively in January. Six-month growth rates were little changed at respectable rates of 2.3% (4.7% annualised) for M3 and 4.3% (8.8%) for M1 – see first chart.

Lending to households and non-financial corporations (NFCs) had contracted by 0.2% in December but more than made up the loss in January, rising 0.3%. Six-month growth ticked up to 0.6% (1.2% annualised).

These trends are stronger in real terms because energy price weakness has pushed the six-month change in consumer prices back into negative territory – first chart. The most reliable monetary leading indicator of the economy historically has been real non-financial M1*. Its six-month growth has moderated since early 2015 but remains solid, suggesting continued economic expansion – second chart. Real non-financial M1 has contracted before every recession since 1970 (at least – earlier data are patchy).

The ECB releases country data on deposits but not currency. Six-month growth of real M1 (overnight) deposits remains respectable in Germany / Italy and strong in Spain / France – third chart.

With little sign that recent economic softening is related to monetary conditions, the case for further policy easing is questionable. As previously discussed, a cut in the deposit rate to -0.4% or -0.5% risks being counterproductive by undermining banks’ ability and incentive to expand their balance sheets and reducing savers' income expectations, causing them to rein in spending. Policy-makers should recognise that a recovery in bank profitability is necessary to support credit creation and economic growth; extending the QE programme to bank bonds would be a good way of signalling this recognition.

*Non-financial M1 = currency and overnight deposits held by households and NFCs.

Monetary trends and leading indicators suggest that G7 economic growth will remain weak through the summer. The message for the E7* large emerging economies is more encouraging.

The first chart shows changes in G7 GDP and industrial output measured over two quarters / six months. Two-quarter GDP growth fell to an estimated 0.5% in the fourth quarter of 2015, or 1.1% at an annualised rate – the slowest since the second quarter of 2014. Industrial output, meanwhile, declined by 1.1% in the six months to December. Note that industrial output is significantly more volatile than GDP, so that a fall of at least 2% over six months would be needed to suggest GDP stagnation or contraction.
The second chart shows six-month changes in industrial output, real narrow money and a composite leading indicator based on OECD data. Real narrow money growth has slowed significantly since early 2015 but remains within its 2011-15 range. It would need to fall beneath this range to suggest a recession. Since the 1960s (at least – earlier data are patchy), every G7 recession has been preceded by a contraction of real narrow money.

The leading indicator, like industrial output, has fallen over the last six months but by less than the 2% GDP stagnation / recession “threshold”.

So both narrow money trends and the leading indicator are currently consistent with a continuation of recent sluggish GDP growth rather than a move into contraction.
The third chart shows the same three indicators for the E7 economies. The six-month change in E7 industrial output turned briefly negative in mid-2015 following a contraction of real narrow money in late 2014. Real money, however, reaccelerated strongly from spring 2015. Industrial output rose slightly in the six months to December and would be expected to pick up pace into the summer, based on the historical relationship.

The leading indicator is also giving a positive message, although has tended to be too optimistic in the recent past.
Divergent G7 / E7 narrow money trends mainly reflect opposite US / Chinese developments. From a monetary perspective, the main concern for global economic prospects is the weakness of US narrow money. The six-month change in real narrow money approached zero in October, recovered in late 2015 but has recently fallen back again – fourth chart**. The latest reading is still consistent with slow GDP expansion rather than a recession but further weakness would be troubling.

Elsewhere in the G7, real narrow money growth has fallen in Japan and, while currently still solid, is showing signs of tailing off in the Eurozone – January Eurozone data are released later this week. The seeming determination of the BoJ and ECB to push rates deeper into negative territory is discouraging for monetary prospects – see previous post.
In the E7, Chinese real narrow money growth is likely to cool from its recent supercharged pace but there is scope for recoveries in Russia and Brazil in response to interest rate / currency stabilisation – fifth chart. Six-month E7 real narrow money growth, therefore, may remain above the G7 level – sixth chart.
*E7 defined here as BRIC plus Korea, Mexico, Taiwan.
**February estimate in chart based on data for first week.