Narrow money growth in the E7 large emerging economies rose further in January, suggesting improving economic and equity market prospects.

With January data available for six of the seven countries, the six-month change in real (i.e. consumer price-adjusted) narrow money* is estimated to have risen to more than 5%, or nearly 11% annualised, representing the fastest growth since October 2010 – see first chart. The six-month change turned negative in December 2014 ahead of economic weakness in 2015.
The pick-up in growth since mid-2015 reflects a combination of stronger nominal money expansion and a slowdown in inflation, with the former dominating.

By country, China has been the key driver but additional boosts have come from a resumption of real money growth in Russia and a slowdown in the rate of contraction in Brazil. Real money expansion remains strong in Korea (latest data point December) and respectable in other E7 countries, although has slowed notably in Mexico – second chart.
Key concerns for emerging market investors are that the US economy will either enter a recession in 2016 or reaccelerate strongly, prompting the Fed to press ahead with interest rate hikes. Current evidence suggests that a middle course of sub-par expansion is more likely.

A recession is not the main case scenario here because 1) US real narrow money has yet to contract, as it has before most prior recessions, and 2) consumer expectations are holding up, suggesting that consumption growth will continue to offset weakness in business spending. Expectations usually fall sharply at the onset of recessions – third chart. Energy price declines have provided important support recently, so an early, large oil price rebound would be concerning.
Strong economic reacceleration is deemed unlikely because 1) US narrow money trends remain weak and 2) the Kitchin inventory cycle is in a downswing. According to revised national accounts data released last week, the ratio of real non-farm inventories to sales of final goods and structures rose to an 18-quarter high at the end of 2015, with the deviation from the long-term downward trend the largest since the second quarter of 2009 – fourth chart. Assuming that final sales grow at a 2% annualised rate, and stockbuilding adjusts smoothly, a return to the long-term trend by end-2016 would imply a drag of 0.5-0.75 percentage points on GDP growth in the year to the fourth quarter.
Emerging market investors are also concerned about Chinese economic weakness. February purchasing managers’ survey headline numbers were modestly disappointing from the perspective of the optimistic view of Chinese near-term prospects here but upcoming “hard” data for January / February will be more important for assessing developments. There were some promising signs in the details of the surveys: for example, order backlogs in the official manufacturing survey rose to a four-month high while activity expectations improved sharply – fifth chart**.

*Narrow money = “true” M1 for China, M1 for other countries.
**Own seasonal adjustment applied to official data.

The consensus expects sluggish UK economic growth in 2016, reflecting global weakness, fiscal tightening and a small or large negative impact from the Brexit referendum – depending on its outcome. Strong money and credit trends suggest upside risk to this forecast.

UK GDP rose by 0.5% in the fourth quarter of 2015 versus an increase of 0.3% in the US and Eurozone and a 0.4% contraction in Japan. Monthly output numbers indicate positive carry-over into the first quarter. A strong rise in unfilled vacancies – a good coincident indicator – in the three months to January suggests a solid start to 2016.

The preferred broad and narrow monetary aggregates here are “non-financial” M4 and M1, comprising money holdings of households and private non-financial corporations (PNFCs). Financial sector money has less immediate relevance for economic prospects.

Non-financial M4 rose by 0.5% in January, pushing annual growth up to 5.8%, the fastest since June 2008. Non-financial M1 increased by 0.8%, lifting annual growth to a 13-month high of 7.8% – see first chart.

Annual non-financial M4 growth was depressed last year by households switching out of bank deposits into National Savings pensioner bonds before the May general election. This distortion is now unwinding as the one-year bonds mature and some cash flows back to the banking system – National Savings lost £150 million in January versus a £6.9 billion inflow a year earlier.

Annual growth in the Bank of England’s favoured broad aggregate, M4ex*, was lower at 4.0% in January, reflecting its inclusion of financial sector money, which contracted by 6.5% in the latest 12 months. Detailed data show significant falls in money holdings of insurance companies and pension funds, other fund managers and securities dealers recently. These declines may have negative implications for financial market prospects but are unlikely to signal any slowdown in household or corporate spending.

Credit trends, meanwhile, continue to strengthen. Annual growth of bank lending to households and PNFCs rose to 3.2% in January, the fastest since March 2009 – first chart. M4ex lending, which includes loans to financial corporations, rose by an annual 3.8%: the financial sector has stepped up its bank borrowing even as money holdings have been run down.

The lending pick-up was signalled by an earlier surge in arranged but undrawn credit facilities; growth in these has moderated but still suggests further lending acceleration – second chart.

The forecasting approach here places emphasis on the six-month rate of change of real (i.e. consumer price-adjusted) money. Major economic slowdowns or recessions have been preceded by sharp falls in six-month changes of real non-financial M1 and / or M4; both aggregates are giving a positive message currently – third chart.

*M4ex = M4 excluding money holdings of “intermediate other financial corporations”.