Brexit uncertainty may at least have prevented the Bank of England from making another policy mistake.

Today’s MPC communications suggest that, absent the Brexit cloud overhanging economic prospects, the Committee would have hiked rates again to counter perceived inflationary risks from a tight labour market. Weak money trends, however, argue that policy settings are already restrictive and the next move may have to be to ease not tighten.

Annual growth rates of four different money measures fell further in September, to the lowest levels since 2012 – see first chart*. Consumer price inflation has also declined this year but by much less, so real money growth has slowed significantly.

The second chart compares annual growth of nominal GDP with that of the four money measures. The monetary slowdown since 2016 has been reflected in a slide in nominal GDP growth, ignoring a small recovery in the second quarter of 2018 (which could be revised away). With money trends still weakening, nominal GDP growth may move down further towards 2% in early 2019. The MPC needs to achieve average growth of about 3.5% per annum to meet the 2% inflation target, assuming potential output expansion of about 1.5% pa.

The monetary slowdown partly reflects policy tightening – the November 2017 / August 2018 rate hikes, closure of the term funding scheme in February 2018 and instructions to banks to conserve capital because of Brexit risk. In addition, Brexit uncertainty and slower-than-expected global growth have dampened business / consumer confidence and spending plans, resulting in a reduction in credit demand and lower desired holdings of transactions money.

Facing possibly significant Brexit-related volatility over coming months, the MPC could do worse than steer policy on the basis of monetary trends. That means eschewing any consideration of another rate hike until money growth recovers, and moving to an easing bias if trends continue to weaken.

*Non-financial = held by the household sector and private non-financial corporations. M1 = narrow money = sterling notes / coin and sight deposits. M4 = broad money = M1 plus sterling time deposits, repos and bank securities of up to five years’ original maturity. M4++ = non-official expanded measure = M4 plus foreign currency deposits, national savings and retail sales of unit trusts and OEICs. M4ex = Bank of England’s preferred broad money measure = non-financial M4 plus M4 holdings of financial corporations, excluding intermediaries.

Global narrow money trends continue to signal a weak economic outlook but have not deteriorated further since early 2018 – a recession warning, in other words, has yet to be issued.

Six-month growth of global (i.e. G7 plus E7) real narrow money moderated in September but, in broad brush terms, has moved sideways since reaching a low in February, remaining below its range over 2009-17. Allowing for an average nine-month lead, the suggestion is that six-month industrial output momentum will bottom out in late 2018 and stabilise at a weak level in early 2019 – see first chart. 

The expected economic slowdown is on track – G7 plus E7 six-month industrial output growth is estimated to have declined to a 26-month low in September, based on data accounting for two-thirds of the aggregate.

Narrow money trends have stabilised across the major economies: the six-month change in real narrow money is above its minimum over the last year in all the G7 plus E7 economies except Mexico and Korea. Real narrow money growth is relatively firm in Japan and Euroland and weak in the US (and China), casting doubt on the sustainability of recent US economic / equity market outperformance – second chart.

While the stabilisation of G7 plus E7 real narrow money growth is reassuring, trends have deteriorated further in smaller Far East economies suffering a triple squeeze from US rate hikes, China’s slowdown and tariff wars – third and fourth charts. These economies are too small to have a significant direct impact on global activity but associated financial stresses could contribute to an extension of the current “risk-off” move in markets, with negative feedback to monetary trends / economic prospects in the major economies.

     The two "monetarist" rules followed here for switching between global equities and US dollar cash recommended cash at end-September. The first rule, which prefers equities if G7 plus E7 six-month real narrow money growth is above industrial output growth, will move back into equities at end-October, since a positive gap was restored in August and appears to have been maintained in September – first chart.

As an aside, G7 plus E7 annual real narrow money growth remained below industrial output growth in August and, probably, September. A switching rule using annual growth rates would also have outperformed buy-and-hold significantly historically but by less than the rule based on six-month changes.

The second rule prefers equities if G7-only annual real narrow money growth is above 3.0%, its pre-GFC long-run average. Growth recovered in September but did not exceed this threshold, so this rule will remain in cash during November – fifth chart.