3rd July 2012 by The Harried House Hunter
UK monetary trends are improving, casting doubt on the wisdom of a likely further expansion of QE at this week’s MPC meeting.
The first chart below shows six-month changes (not annualised) in a range of real broad and narrow money supply measures (i.e. deflated by consumer prices, seasonally adjusted)*. All six measures were contracting a year ago, signalling likely economic weakness. In all six cases, the latest six-month change (i.e. to May 2012) is significantly higher than then and also up from late 2011. In five of the six cases, the recent pick-up reflects faster nominal expansion as well as a smaller inflation drag as consumer prices have slowed.
Because of recent volatility in financial sector money holdings (not just “intermediate other financial corporations”), the broad and narrow measures currently preferred here are non-financial M4 and M1, i.e. M4 and M1 held by households and private non-financial corporations. In real terms, these measures rose by 1.3% and 1.1% (not annualised) respectively in the six months to May – the largest increases since April 2009 and January 2010 respectively.
The second chart shows that real non-financial money has predicted recent swings in the economy, with the latest six-month M4 and M1 increases suggesting a return to respectable expansion by late 2012 / early 2013, allowing for the usual lead of six months or so.
A further monetary injection could be argued to be warranted to cement such a prospect but runs the risk of creating “excess” liquidity that will sustain a medium-term inflation overshoot and / or lead to new asset price bubbles and subsequent destructive busts.
*The range does not include the headline M4 measure, which continues to be distorted by declining deposits of economically-irrelevant “intermediate other financial corporations” (IOFCs). (M4 is routinely quoted without qualification by proponents of “radical” monetary easing, such as the FT’s Martin Wolf.) M4 comprises the private sector’s holdings of sterling notes and coin and bank deposits at UK banks, along with repo claims and bank paper of up to five years’ original maturity. M4ex, the Bank of England’s preferred broad measure, excludes money holdings of IOFCs. “M4ex+”, as defined here, adds foreign currency deposits at UK banks (excluding those held by IOFCs). Retail M4 includes only bank deposits with an advertised rate (i.e. not “wholesale” deposits). M1 comprises sterling notes and coin and sight deposits.