Janus Henderson: Euroland money trends - false positive?

December money numbers released yesterday were, on the face of it, positive. Six-month growth rates of real narrow and broad money (i.e. non-financial M1 and non-financial M3*) rose notably, in the latter case to an 18-month high – see first chart. Allowing for a typical nine-month lead, the suggestion is that GDP growth will rebound in the second half of 2019.

There are, however, grounds for caution. Stronger real narrow money growth has been driven by a slowdown in inflation, reflecting pass-through of weaker energy and food commodity prices, with nominal money trends stable – second chart. Inflation is likely to recover unless commodity prices weaken further, so real money growth could fall back.

The stronger performance of broad money, which has accelerated in nominal as well as real terms, could be argued to warrant optimism. Narrow money, however, has outperformed broad money as a leading indicator historically. Real broad money growth rose in 2010 and 2015 without a corresponding pick-up in narrow money; the economy subsequently slowed – first chart.

The ratio of narrow to broad money, indeed, has itself been a reasonable leading indicator of activity historically; this ratio continues to slow – third chart.

A further reason for caution is that narrow money trends may be starting to diverge across economies. Italian real non-financial overnight deposits contracted in the six months to December – fourth chart. A core / periphery divergence opened up before the 2009-10 and 2011-12 recessions. Euroland-wide GDP reacceleration is unlikely if the Italian economy is moving into recession.

The ECB's fourth-quarter bank lending survey released last week, meanwhile, indicated less favourable expected trends in credit supply and demand – fifth and sixth charts. A slowdown in private sector lending could dampen broad money growth.

An interesting question for monetary anoraks is why broad money growth has picked up despite slowing QE. The counterparts analysis of the headline M3 measure shows that a fall in the government contribution to money growth, which incorporates the QE effect, has been more than offset by a shift from contraction to expansion in the banking system’s net external assets – seventh chart.

The interpretation here is that QE boosted domestic credit expansion but had little impact on broad money because “excess” liquidity was exported through the non-bank capital account of the balance of payments – the contraction of banks’ net external assets was the mirror-image of this capital outflow. With QE slowing, the outflow fell in the second half of 2018 and was smaller than the current account surplus, resulting in banks’ external position contributing positively to monetary growth. The stronger “basic” balance of payments position, i.e. current account plus non-bank capital account, could support the euro – eighth chart.

* Money holdings of financial institutions are excluded because they are volatile and unlikely to be relevant for assessing near-term prospects for spending on goods and services.