UK monetary statistics for September suggest that strong economic expansion will continue at least through spring 2014.
The forecasting approach here focuses on six-month growth of real narrow money, as measured by non-financial M1, comprising cash and sight deposits held by households and non-financial firms. This rose further to 5.3% in September, or 11.0% annualised – see first chart. Current growth is the highest since August 2004, ahead of an economic boom*.
Real non-financial M1 has been an excellent predictor of the economy in recent years, signalling the 2008-09 recession, 2010 rebound and 2011-12 “soft patch”, as well as this year’s acceleration – first chart. The ECB this month published research showing that Eurozone real non-financial M1 has a “robust” leading relationship with GDP fluctuations. The Bank of England, by contrast, ignores the UK aggregate – it is a safe bet that no MPC member is aware of the recent surge.
Real non-financial M4, a broader measure also including time deposits and cash ISAs, grew by a moderate 1.2%, or 2.4% annualised, in the six months to September – first chart. M4 has displayed a looser relationship with the economy and is probably understating the degree of monetary stimulus at present, since the further large drop in deposit interest rates over the past year is likely to have depressed the demand to hold broad money. Put differently, the fall in rates has boosted the velocity of circulation of broad money – this is indirectly captured by the surge in M1.
Real narrow money growth is notably stronger than in the rest of the G7, suggesting that recent economic outperformance will continue – second chart.
The “monetarist” rule is that money supply changes affect economic activity in the short run but filter through to prices after about two years. The downside of recent monetary trends is that the current decline in inflation is likely to reverse from early 2014 in lagged response to faster money growth since 2011. The MPC may face a “crunch point” next spring as unemployment nears 7%, the housing market overheats and inflationary clouds darken.
*Gross value added excluding oil and gas rose by 5.3% in the year to the fourth quarter of 2005.