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Economics Weekly - Falling money supply suggest global recovery not secure; Weekly economic data preview - OBR forecasts to set the tone in a busy week for UK data

Economics Weekly - 14 June 2010


Falling money supply suggest global recovery not secure


In all of the furore surrounding the sovereign debt crisis in Europe and the impact on the euro and US dollar, attention has drifted from some recent developments in monetary data that suggest all is not well with the global economy. In summary, broad monetary data are suggesting that the world economy is operating at two speeds. In the developed economies, money supply data suggest that the economic recovery, though underway, is not secure and growth is slow, see chart a. By contrast, money supply for some key emerging market economies suggests that the economic recovery is robust and growth is fast, see chart b. However, this may be a misleading conclusion to draw, as should the

developed economies falter, there will be significant negative trade implications for growth in the emerging market economies as well.


Looking at the growth rate of broad money supply in the developed economies shows that whilst the very sharp deceleration from the levels prior to the financial crisis has eased it has not yet ended. Annual growth rates do appear to be stabilising, though at a negative rate in the euro area and at about 2 to 3% in the US and UK. On the surface, this would suggest that there are serious liquidity tensions in the euro area economies – dovetailing, of course, with actual evidence of the pressures facing Greece and some other smaller EU economies.


Whilst US and UK broad monetary growth is not negative there has to be serious concern about whether the growth that is occurring is enough to provide strong support to economic recovery. For sure, the slow rate of growth of money supply being registered in all these economies is inconsistent with any sustained surge in price inflation. Admittedly, price inflation is very low in the euro area and in the US but that is not the case in the UK, where annual CPI inflation is currently 3.7%. However, the monetary data are suggesting that whatever the observable price inflation in the UK it is unlikely to persist, unless monetary growth took-off, which seems unlikely.


Taking the UK as an example of recent economic trends, see chart c, there has been a sharp rise in nominal gdp growth in the last six months. On the surface, this seems at odds with the continued fall in broad money supply shown in chart a. Using the Bank of England’s preferred measure of money supply (M4 excluding activity between intermediate financial institutions) shows, however, that there has been an annualised rise of 6.6% in the three months to April. This is consistent with the 6-9% range that the MPC said it was aiming for when it initiated QE back in March 2009.


Interpreting this in too positive a light however may not be straightforward. As chart d shows, the money holdings of companies and households in the UK has barely grown at all in recent months. That said, without QE there may well have been a fall in these money holdings, and the economic downturn is likely to have been deeper and perhaps lasted for longer than the six quarters recorded. Admittedly, it remains the case that the money being created by QE needs to find its way into real economic activity and spent not saved. Recent UK saving trends from households and companies, however, suggest quite a bit of the increase in M4 has not been spent. In this context, however, the turnover of money in the economy is also important because although money supply may not be rising, its turnover may be and that would allow for speedier growth. Unfortunately, the ratio of the level of gdp to money supply M4 fell in Q1 2010.


Turning back to the key developed economies’ monetary statistics shows a pattern pretty consistent with that of the UK, except that it is worse in the case of the euro zone economies. As chart e depicts, holdings of broad money by households in the eurozone is falling sharply. Admittedly, holdings by companies are now positive after a period of negative growth, and seem to be offsetting the fall in household activity as far as total economic growth is concerned. However, it is noticeable that in the last six months economic growth in the euro zone has virtually ground to a halt. That is consistent with the poor money supply backdrop shown here; suggesting that until it changes a sharp rise in growth in the euro area is highly unlikely.


For the US, the monetary picture is similar to that of the UK and euro area, though the rise in non financial company’s holdings of broad money has been stronger than in the UK or eurozone. This means that it is company activity in the US that is driving the economic recovery there, consistent with the evidence from its real economy. That said, the US recovery is not yet sufficiently robust to withstand severe shocks.


Overall, the monetary analysis undertaken here highlights the need for cautioun about growth prospects in the major advanced economies. In turn, this means near term inflation pressure will not prompt policy makers in any of these economies to raise official short term rates at this time. Although economic growth is much more rapid in the emerging market economies, they are more dependent on activity in the developed economies than is commonly supposed and cannot ignore the fall-out from problems in those economies. However, it would seem prudent for many of the emerging market economies to start hiking rates from now, allowing scope for cutting them later on if conditions take a turn for the worse. This is, of course, what many of them are now doing, including Brazil, China and India. Such moves, however, starkly illustrate quite how the dynamics of the world economy have changed.


Trevor Williams, Chief Economist


Weekly economic data preview 14 June 2010


OBR forecasts to set the tone in a busy week for UK data


􀂄 The UK economic calendar is a busy one this week, with key inflation, labour market, retail sales, money supply and public sector finance data all due. The newly formed Office for Budgetary Responsibility (OBR) is also due publish its first report, outlining its economic forecasts and the implications for the fiscal finances based on existing policies. All these events have the capacity to move the sterling markets, although the OBR’s assessment is likely to attract particular attention ahead of the Emergency Budget on 22 June.


􀂄 Following the downward revision of last year’s public sector net borrowing requirement from £167bn to £156bn, the starting point for the OBR’s fiscal projections is a little more favourable. Nevertheless if, as widely expected, the OBR presents a weaker set of economic forecasts than those used by the previous government, the medium-term outlook for the public sector finances is likely to be worse than published in the March 2010 Budget - underscoring the need for fiscal consolidation. The inflation figures will also be watched closely, particularly after last week’s BoE Inflation Attitudes survey revealed that the public’s 12-month inflation expectation rose to 3.3%. We expect headline CPI to have dropped back from 3.7% to 3.4% last month, as the base effects associated with last year’s fall in the pound and excise duty increases in the April 2009 Budget drop out of the annual comparison (note: the Budget in 2010 was a month later than this year).


􀂄 The labour market release is expected to continue to paint a mixed picture. While claimant unemployment is forecast to have fallen a further 20k in May, there is little sign that this is yet translating into an improvement in job prospects. Indeed, in recent months, the level of employment has continued to fall. Given the backdrop of a weak labour market and the pending fiscal tightening, the consumer sector continues to face significant challenges. Retail sales rose by just 0.1% in April. We expect another subdued monthly increase (0.2%) in May. A further reminder of the need for fiscal austerity is likely to be provided by the latest monthly public finances report, with the PSNB forecast to have totaled £20bn in May. Finally, the latest M4 money supply data are forecast to show little improvement, with broad money expected to have expanded by just 0.2% last month (3.2% on the year).


􀂄 Uncertainties cloud the economic outlook in the euro zone and sharp focus will be on the German ZEW sentiment index on Tuesday. Although developments in the currency and sovereign credit markets are expected to have dominated investor sentiment in May, we are predicting a modest improvement in the economic sentiment index from 45.8 to 46.1, mainly due to the announcement of the emergency financial package which removed some of the uncertainties surrounding the survival of the euro. Lower energy prices are expected to have resulted in a flat monthly reading for German PPI in May.


􀂄 It is a relatively busy week for US data. All three price indices: import prices, producer prices and consumer prices are expected to show a fall in May on energy costs, nudging their respective annual rates lower. The latest production data are forecast to show activity remains brisk, with official figures for industrial output expected to show another 0.8% gain in May and also solid outturns for the June Empire and Philly Fed manufacturing surveys. After a strong rebound in April, we look for a fall in housing starts due to the expiration of the home buyer tax credit. It will be interesting to see how demand holds up in coming months. Speakers this week include Fed Chairman Bernanke on Wednesday.


Adam Chester, Sian Fenner and Jeavon Lolay


Lloyds TSB Corporate Markets Economic Research, 10 Gresham Street, London, EC2V 7AE, Switchboard: 0207 626 1500. Bloomberg: LLOY<GO>



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