Available June industrial output data suggest that the global economy was picking up at mid-year, consistent with an earlier revival in real narrow money growth, which strengthened further last month. A positive view of economic prospects will be maintained here unless narrow money trends weaken, with such a weakening deemed unlikely.

The US, China and Russia have released June industrial output data, together accounting for 50% of the G7 plus emerging E7 aggregate tracked here. Results were above expectations in all three cases. Assuming no change in output from May in the other countries, six-month growth of G7 plus E7 output will have risen to 0.8%, or 1.6% at an annualised rate, the fastest since February 2015 – see first chart.

A mid-year pick-up had been suggested by global narrow money trends: six-month growth of G7 plus E7 real narrow money bottomed in August 2015 and rate of change turning points have led those in industrial output by an average of nine months historically. Real narrow money growth strengthened further last month, based on data covering the US, China, Japan, India and Brazil, together accounting for 67% of the G7 plus E7 aggregate. The current economic upswing, therefore, may extend through March 2017, at least.

Will Brexit affect monetary trends and the economic outlook? Narrow money is demand-determined, with demand influenced importantly by the spending intentions of firms and households, explaining why it leads the economy. The Brexit shock may dent confidence temporarily but spending plans should be supported by a post-vote fall in interest rate expectations. Narrow money trends, therefore, may remain solid, except (probably) in the UK. US narrow money in the latest week, ending 4 July, was 0.8% above its June average level.

As previously discussed, the economic significance of narrow money strength is often disputed on the grounds that zero / negative interest rates are putting downward pressure on the velocity of circulation. As long as the rate of change of velocity is less volatile than that of real narrow money, however, turning points in the latter should still signal future turning points in economic momentum. The value of a forecasting approach that identifies the future direction of economic growth should not be underestimated.

The relationship between levels of real narrow money and economic growth, moreover, can be partially restored by adjusting for a long-run downward trend in the rate of change of velocity. The red line in the second chart incorporates such an adjustment, while also allowing for the average nine-month lag between money and output changes. The fit of the relationship shows no sign of deterioration in recent years – industrial output growth was close to the “forecast” in June, with a significant pick-up indicated.

The green line improves the fit slightly further by incorporating the slope of the G7 government yield curve, which is widely monitored as a long leading indicator. The suspicion here is that the information content of the yield curve has been reduced in recent years by unprecedented market intervention by central banks. A flattening of the curve over the past year tempers but does not offset the positive signal for economic prospects from narrow money trends.

The stock of UK notes and coin in circulation was growing strongly before the Brexit referendum and the rate of increase has risen further since the vote. This may indicate resilience in retail spending. Alternatively, the public may be “hoarding” cash in expectation of negative interest rates and / or restrictions on the supply of £50 notes.
    
Annual growth in notes and coin reached a seven-year high of 7.4% in April / May, remaining strong at 7.0% in June (month averages). Weekly statistics on the note issue indicate a further pick-up since the Brexit vote. As of last Wednesday (13 July), the stock of notes was 8.9% higher than in the corresponding week in 2015 – see first chart.


The annual change in real notes and coin (i.e. deflated by consumer prices) has displayed a significant contemporaneous correlation with the annual change in retail sales volume since the late 1980s (at least) – second chart*. The relationship, however, broke down temporarily around the turn of the century and during the 2008-09 financial crisis as worries about the banking system caused the public to hoard cash**. The Brexit vote is unlikely to have prompted similar concerns. Strong notes growth, therefore, may indicate that retail spending has remained solid since the referendum.


Alternatively, people may be hoarding notes not for safety reasons but because the Bank of England is expected to cut interest rates significantly, possibly even imposing a negative rate on bank reserves, forcing banks to start charging for operating current accounts. The Monetary Policy Committee has signalled that policy will be eased in August and the Bank’s chief economist, Andrew Haldane, has advocated a “sledgehammer” approach. Mr Haldane mused approvingly about negative rates in a speech last year and may wish to use the Brexit vote as an excuse to launch such an experiment.

Hoarding may also reflect increased demand for £50 notes due to uncertainty about their future supply. According to the Bank’s 2016 Annual Report, the value of £50 notes in circulation rose by 11.6% in the year to end-February, while lower-denomination notes increased by only 5.1%. Governor Carney confirmed in June that there are no plans to introduce a plastic version of the £50 note, fuelling fears raised by Mr Haldane’s earlier speech that the Bank intends to restrict the future supply of cash in order to create scope for interest rates to fall further below zero.

*Correlation coefficient = 0.61 since 1989.
**The concerns in late 1999 reflected the possible impact of the Y2K changeover on banks’ computer systems.