The Chinese economy has cooled since early 2017 but growth remains respectable and current monetary trends are reassuring.

Nominal GDP is a better guide to economic fluctuations in China than official real GDP growth numbers, which often show little variation. Two-quarter growth of nominal GDP, seasonally adjusted, peaked in the first quarter of 2017, falling significantly in the second and third quarters. A slowdown had been signalled by a sharp drop in six-month narrow money expansion between August 2016 and February 2017 – see first chart*.

Narrow money growth, however, has stabilised since early 2017 at a solid level by historical standards. Current growth is much stronger than in late 2014 / early 2015, when the economy was in danger of entering a deflationary recession. Aggressive monetary and fiscal policy easing averted this risk and set the stage for the late 2016 / early 2017 boomlet.

Monetary pessimists highlight weakness in broad money M2 – six- and 12-month growth of this measure recently reached new lows in data extending back to the early 1990s. As previously discussed, however, M2 has been distorted by large swings in deposit holdings of non-bank financial institutions – movements in such deposits are unlikely to provide information about near-term prospects for spending on goods and services.

An additional suppressing factor since 2015 has been a switch by households and non-financial enterprises out of time deposits into money market funds and wealth management products, which have channelled the funds back to the banks via purchases of bank bonds. Such bonds are excluded from the M2 definition.

An adjusted broad money measure excluding financial deposits and adding bank bonds has been better correlated with nominal GDP than M2 in recent years – second chart. Six-month growth of this measure is below the historical average but has recovered since June and is higher than in late 2014 / early 2015.

Broad money, therefore, is giving a less upbeat message than narrow money but does not suggest economic weakness.

The expectation here, based on the above, is that nominal GDP growth will stabilise around its recent lower level through early 2018.

One risk to an optimistic view is that policy tightening during the first half of the year has yet to be fully reflected in monetary trends. Near-term economic resilience, moreover, may sustain recent upward pressure on inflation, causing further restrictive policy moves.

*True M1 = official M1 + household demand deposits.

Today’s news of a further rise in UK consumer price inflation to 3.0% in September supports the case for the MPC to raise interest rates in November but does not provide additional hawkish information relative to the August release.

CPI inflation averaged 2.82% for the third quarter as a whole versus a projection of 2.68% in the August Inflation Report. The MPC then expected a further rise to 2.75% in the fourth quarter; current trends suggest an average of 3.0%.

CPI inflation just made it to 3.0% in September: the unrounded figure was 2.96%.

The rise from August was driven by food inflation, which jumped from 2.3% to 3.4%. A post last month noted that CPI food inflation was unusually low relative to producer output price inflation of food products, which reached 6.0% in July and remained elevated at 5.5% last month. A further rise in CPI food inflation, therefore, appears likely.

The September data collection date preceded a 12.5% increase in the British Gas standard electricity tariff on 15 September – this will lift annual inflation by a further 5-10 basis points in the fourth quarter.

Core prices are still rising at an above-target pace. The core measure monitored here excludes energy, food, alcohol, tobacco and education, and adjusts for historical VAT changes. Seasonally adjusted, core prices rose by 0.2% between August and September and at a 2.6% annualised rate in the latest three months – see chart.

As previously discussed, the claim that the inflation overshoot is entirely attributable to sterling weakness has become more difficult to sustain following data revisions showing unit labour cost growth of 2.4% in the year to the second quarter.

The view here remains that the rising inflation trend stems from a significant pick-up in money growth from 2011, with this faster expansion subsequently contributing to the fall in the exchange rate – see previous post. Annual broad money growth appears to have reached a peak in late 2016 but has usually led inflation turning points by at least two years historically, suggesting that upward pressure will persist in 2018.

The IMF’s latest World Economic Outlook (WEO) – a useful summary guide to the views of the global policy-making consensus – is upbeat about economic prospects. Monetary trends, by contrast, suggest that GDP growth will slow in 2018. This is the reverse of the position a year ago, when the IMF consensus was gloomy* but money trends were signalling – correctly – that growth would surprise on the upside in 2017.

The IMF now expects its global GDP measure to grow by 3.6% in 2017, up from 3.5% in July. It forecasts a further increase to 3.7% in 2018, implying that growth next year will be the strongest since 2011.

The key forecasting indicator here is six-month growth of global real narrow money**. This appears to have fallen sharply in September, based on monetary data for countries accounting for two-thirds of the aggregate – see first chart. Six-month growth peaked most recently in June. Allowing for a typical nine-month lead, this suggests that the global economy will lose momentum around spring 2018.

The latest decline in six-month real narrow money growth follows a temporary slowdown in late 2016 / early 2017. Together, these have resulted a significant fall in year-over-year real money growth, from a peak of 9.8% in September 2016 to about 6% last month – second chart.

The monetary slowdown, as well as signalling a likely moderation of economic growth in 2018, implies a reduction in current liquidity support for markets. The gap between year-over-year real narrow money growth and industrial output expansion, monitored here as a gauge of the potential money flow into markets, has fallen to its lowest level since 2014 – second chart.

Another development suggesting reduced support for global markets is a sharp slowdown in Japanese portfolio investment overseas. On a 12-month rolling basis, Japan’s portfolio investment balance has swung from a deficit of ¥40.5 trillion or $370 billion in September 2016 to a small surplus in August 2017 – third chart. This mostly reflects a decline in Japanese purchases of foreign securities, which has coincided with a slowdown in QE since the Bank of Japan introduced its "yield curve control" policy – fourth chart

*The October 2016 WEO was entitled “Subdued demand: symptoms and remedies”.
**”Global” = G7 plus emerging E7. Real = adjusted for consumer price inflation. Narrow money = currency in circulation plus demand deposits or equivalent.