Economics Weekly 15 December 2008; Weekly economic data preview W/c 15 December 2008
Economics Weekly 15
With the release of the
latest UK monetary statistics this
week, the spotlight should shine on what has been happening to money supply
since the credit crisis broke in the summer of 2007. If the economic slowdown
is going to be exacerbated by the credit crisis, then this is where the bad
news should be
evident. On the
surface, there does not appear to be a problem at all with credit growth. UK money supply expanded by 15.3% in
the year to October 2008, up from a rise of 12.4% in December 2007 and 10.1% in May this year. But this
aggregate figure is very misleading. If the activities of other financial
institutions (OFIs) are excluded, a completely different profile is revealed.
On this adjusted basis, money supply rose by just 3.5% in the year to October
2008, down from 8.9% in December 2007 and 6.6% in May, see chart a.
transactions amongst financial firms shows money supply is falling at an
But why leave out OFIs?
The answer is that this sector contains the specialist financial companies that
were most active in creating the credit instruments that lie at the heart of
the current global financial market crisis. Many are now being wound up, are
hoarding cash to meet obligations, and receiving loans from parent companies or
from selling assets in order do so. In October, bank lending to OFIs rose by
42.8% on the year before, and M4 deposits by them were up by 44.1% in the same
period. These flows, and the behaviour driving them, is distorting, at the
aggregate level, the overall picture of what is happening to lending and deposit
flows by households and companies in the UK. The trend in real 'inflation
adjusted' M4, shown in chart c, is bad news
for the economy. M4 money supply deposit growth and lending growth are
weakening dramatically, reflecting, of course, tougher credit standards, wider
spreads and less credit demand as households cut back on spending and companies
cut investment and costs, see chart b. In October, annual bank deposit growth
by households was 6% up from a year earlier, but down from an 8.8% increase at
end-December 2007 and from 8.9% growth as recently as May. For companies, the
fall-off in deposits has been even sharper, with deposit growth moving from an
annual rise of 9.8% at the end of 2007, to a fall of 5.2% in October, see chart
b. With these sorts of data now becoming the norm, it is no wonder that retail
sales growth has fallen sharply and that company investment spending is being
cut aggressively and hence that unemployment is now rising sharply.
â€¦with deposits by the
company sector falling for the first time since the 1980s and household deposits
down sharply from a year ago, despite policy looseningâ€¦
Chart b illustrates the
extent that money supply trends have turned down alarmingly for the
non-financial corporate sector in the UK. This further explains
the need to adjust the headline M4 money supply total by excluding the
transactions taking place in the OFI sector in order to understand what money
supply trends really mean for the economy. Companies are dipping into deposits,
down by 5.2% in the year to October, to survive as lending growth weakens.
Households are not in such a dire position, but they too are seeing weaker M4
lending growth as mortgage markets weaken sharply. However, lending growth
roughly matches deposit growth, implying more balance than in the corporate
â€¦all of which points to
the severity of the pressures on these sectors, which will lead to a fall in UK
economic growth of 2% or so in 2009 and a muted recovery in 2010
There are two main
economic effects at the macro level that falling growth in the adjusted M4
measure imply. The first is sharply lower near term price inflation. Chart d
illustrates this clearly, with substantially less money in the system how can
there be rising price inflation? This means that there is scope for Bank rate
to fall to even lower levels than the current 2%, as the inflationary backdrop
remains very weak. The data do not yet however suggest that the UK is on the verge of
persistent price deflation - or falling prices year in year out - though retail
price inflation could be negative next year due to cuts in VAT and official
interest rates. The other implication, as shown in the final chart, is that UK economic growth could
fall as low as it did in the 1990s recession. This implies a fall in gdp next
year of 2.3% and only a weak recovery in 2010, of around 1% Unfortunately,
looking at the recent purchasing managers' indices (services, construction,
manufacturing), retail sales, surveys of business and consumer sentiment and
unemployment, they seem to confirm the depth of economic slowdown that the
monetary data are suggesting. But official policy has responded aggressively in
this downturn and quite quickly, with interest rates likely to be cut further
below 2% in early 2009 and significant fiscal easing already in place. The one
bit of good news is that this does imply that the recession should not be on
the scale of the 1980s or the 1970s but does look on course to match the 1990s downturn.
Another set of weak UK
economic data and the minutes of the 3/4 December Bank of England meeting â€“
which will probably show unanimous support for the last MPC interest rate cut
of one percentage point to 2% while keeping open the option of cutting rates
again soon - could increase negative sentiment towards sterling. Elsewhere, the
US Fed is almost certain to lower its funding rate by at least 50bp to 0.5%,
the Norwegian central bank will reduce official rates by at least 50bp to 4.25%
and the Bank of Japan will hold rates at
0.3%. In terms of data, US, UK and the EU-15 (final) CPI inflation reports for
November will confirm that prices on a monthly basis are falling, providing
additional justification for further monetary easing. We will be looking to see
whether or not monthly UK claimant count unemployment and weekly US initial
claims figures worsen, adding to concern that the UK and US recessions are
â€˘ We are expecting more
bad news about the UK economy, paving the
way for further reductions in interest rates possibly next month. Labour market
data will attract widespread interest on Wednesday as the extent of job cuts by
firms is important in assessing the depth of the current recession - we expect
claimant count unemployment to rise by 40,000, bringing the cumulative total to
226,000 since February. In addition, the CBI distributive trades survey for
December and official retail sales volume figures for November are both likely
to show further contraction - this has evidently led to heavy price discounting
in the shops. Official consumer price inflation for November is also published
and should reflect the trend of weaker price expectations shown in the latest
quarterly BoE/GfK NOP Inflation Attitudes survey (the median 12-month inflation
expectation was 2.8%, significantly below the record high of 4.4% in the
previous quarter). CPI inflation is likely to have fallen by at least 0.2% in
November, representing a decline in the annual growth rate to 4%, compared with
4.5% in October. RPI could fall as low as 3.2% as cheaper mortgage payments
have a dampening effect. Public finance and money supply data are also
published this week, for more on the latter see the main article.
â€˘ Although considered
virtually a done deal that the US FOMC will cut interest rates by 0.5% at on Tuesday, financial markets will look for confirmation
and assess the accompanying statement, which will highlight the supporting
economic rationale. As well as weekly initial jobless claims and CPI inflation
for November, a selection of other domestic and external data will provide
useful insight into the current state of the US economy. This data
include official industrial production for November and the Empire Manufacturing
and the Philadelphia Fed Surveys for December, which are all expected to show
declines. Firms' capacity utilisation levels are expected to stay around 76%.
In addition, lower housing starts and building permits will thwart any hopes
that lower official interest rates have had a beneficial effect on the
beleaguered housing market. External data include the Q3 current account
deficit, which may to fall to -$180bn from -$183bn in Q2, but this still leaves
the US with a massive funding
requirement. Treasury International Capital Data for October will inform on foreign appetite
for US investments - we are expecting an inflow of $40bn in October ($66.2bn in
â€˘ A range of EU-15
business surveys for December will be collectively weak, but will they be worse
than last month? As well as the aggregate figures, the PMI manufacturing and
service surveys will provide interesting detail on regional
differences, as well as information on firms' price,
employment and new business expectations. The German IFO business survey fell
close to a 16-year low of 85.8 in November and the consensus forecast is for a further
decline to 84.0 in December, due to factors such as the strong euro and weak
home and overseas demand. Speeches by ECB President Trichet and a selection of
other ECB members will be gleaned for clues as to the timing and size of
further ECB interest rate cuts - we expect another cut soon.
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