Broad money growth bottoms out, monetary policy tightening continues

  • Global broad money growth seems to have bottomed out – and improved in the USA
  • Money and other indicators imply activity will diverge, US improving, EA slowing
  • But most central banks remain in tightening mode, meaning yield curves will remain flat

My previous comment (Don’t underestimate central banks’ determination to normalise policy) noted that a key driver of central banks’ current behaviour is the urge to exit what they still perceive to be ‘unconventional’ policies.

This view was confirmed by the ECB’s June announcement that euro area quantitative easing – or at least the purchase phase of QE – will come to an end in December. True, the ECB said that interest rates will remain unchanged at least over the summer of 2019; but, equally, also gave the impression that by then, interest rates will rise. That also seems to be the general market impression. On 19thJune, I chaired a ‘target table’ discussion at the Euromoney Global Borrowers & Bond Investors Forum. The theme was, ‘What has to happen before the ECB raises interest rates?’ Interestingly enough, the table was unanimous in feeling that the ECB will raise interest rates in H2 2019, regardless of what happens to the economy. At the same time, the Fed is sounding more hawkish than before; and the Bank of England is also shifting towards more tightening, as is the Bank of Canada.

On this basis, an observer would be justified in believing that the world economy is still facing a synchronised upswing. Yet, that is far from being the case. Judging by monetary developments, but also by other leading indicators, the world economy is if anything, diverging.

Looking first at the United States, it seems that the outlook for late 2018 and early 2019 is improving. Admittedly, this could still be derailed by a trade war (probably more by the sentiment surrounding this than by the actual impact, which is likely to be slower in coming).

There are two reasons for saying this. First, and most important, broad money growth, which slowed sharply in early 2018, seems to have recovered somewhat. It is still well below the 5-7% that would be preferable and consistent with trend rate output growth, but at 3.7% in the year to May, it is the fastest since January. This may be connected with a pick-up in the growth of large (i.e., above $100,000) time and savings deposits, in turn probably due to repatriation of corporate funds held abroad. Nevertheless, broad money growth has at least stopped slowing and begun to recover, while the growth of credit now seems to be moving sideways.

The positive monetary news is accompanied by good news from most other leading indicators. Both business and consumer sentiment are healthy without being excessively strong. Crucially, most indicators continue to surprise on the upside. The one fly in the ointment is the housing market, which is weakening slightly, but this is partly due to a lack of inventory rather than weak demand.

By contrast, monetary trends in the other major economies remain disappointing. In East Asia, Japanese broad money growth has slowed from an average 12-month growth rate of 3.3% over the period October 2016 to December 2017, to 2.7% in the first five months of 2018. Chinese broad money growth has been below 9% since March and for six of the past ten months. By way of comparison, Chinese M2 growth only fell below double digits in two months (April 2015 and May 2017) for the entire period since records began in 1986. Moreover, on a six-month annualised basis, a better guide to recent trends, both Japanese and Chinese broad money growth is pointing to further weakness.

In Europe, both UK and euro area (EA) broad money growth seems to have stabilised, with small increases in May, in both cases to 4%. This is actually faster than in the USA, but in contrast to the US, it represents a sharp slowdown compared with six months earlier. In a key difference between the two large European economies, UK indicators are currently coming in as expected or slightly better; while EA indicators not only are weakening, but are generally weakening more than expected (again, in each case with exceptions). On this basis, EA activity will slow further in the second half of 2018, while UK economic growth should hold up.

However, when it comes to monetary policy, it seems none of this will matter. The Bank of Japan will not move and the People’s Bank of China is currently easing policy. But the major ‘western’ advanced economy central banks (Fed, Bank of Canada, Bank of England, ECB) are all firmly set in tightening mode. To some extent because in spite of a growth slowdown, economic activity remains above trend (partly a consequence of trend growth having come down in the wake of the Great Recession). But mainly because central banks are really extremely keen to get out of what they still perceive to be temporary unconventional policies.

This desire is not absolute. There are some factors that could force a change in policy stances. Among these are:

  • A substantial growth slowdown or even recession. However, that does not, fortunately, seem to be on the cards. But growth is still likely to slow down enough for yield curves to continue to flatten.
  • An EA crisis, brought on by Italian politics or – and more seriously, because it is less soluble and containable – by immigration.
  • An economic or geopolitical crisis brought on by President Trump (the collapse of NATO? Global trade war? Possibly others.)
  • A complete breakdown of Brexit negotiations, followed by no preparation for the UK leaving the EU in March next year.
  • Post-World Cup Russian adventurism.

Absent these or similar developments, however, global monetary policy will continue to tighten over 2018 and 2019.