Janus Henderson: Euroland money trends cooling

The consensus interpretation of September monetary data, released yesterday, is likely to be upbeat. Annual growth rates of broad money M3 and narrow money M1 rose slightly, to 5.1% and 9.7% respectively, with the latter representing a 17-month high.

The forecasting approach here, however, focuses on non-financial monetary aggregates, i.e. excluding holdings of non-bank financial institutions – such holdings are less relevant for assessing near-term prospects for spending on goods and services. Headline M3 / M1 expansion has been supported in 2017 by a recovery in financial sector money growth following weakness in 2016. Annual growth of non-financial M3 has fallen from 6.1% in March to 5.0% in September, with non-financial M1 expansion retreating from 10.1% to 9.2% over the same period – see first chart.

The year-over-year figures, moreover, conceal a sharper decline in six-month growth rates. Non-financial M3 rose by 1.7% or 3.4 annualised in the six months to September, with non-financial M1 up 3.4% or 7.0% annualised; these increases are the smallest over six months since 2014 – second chart.

With six-month consumer price inflation recovering from a decline in the first half of 2017, six-month growth of the non-financial money measures expressed in real terms is also the lowest since 2014 – third chart.

Real money growth remains respectable by longer-term historical standards, suggesting a modest loss of economic momentum rather than weakness. Any slowdown, however, could surprise a consensus relying on continued loose ECB policy – confirmed by yesterday’s news of a nine-months-plus extension of QE – to sustain a strong economy.

Why are money trends cooling despite ECB support and gradual banking-system healing? One probable driver is rising bond yields – average 7-10 year government yields in July 2017 were 60 basis points higher than in July 2016, representing the largest year-on-year rise since 2011. The fall in yields in response to yesterday’s ECB news may prove short-lived against a backdrop of rising US yields and a weakening euro.

ECB research found that real non-financial M1 has outperformed other money / credit aggregates as a leading indicator of the economy, with real M1 holdings of non-financial corporations displaying a stronger correlation with future GDP expansion than those of households. Six-month growth of real corporate M1 deposits was above that of household deposits in September but has fallen sharply since June – fourth chart.

The country M1 deposit breakdown, meanwhile, hints at economic damage from Spanish political turmoil: six-month growth of real M1 deposits in September was the lowest since 2014. A rise in Italian growth, by contrast, suggests improving relative economic prospects – fifth chart.