This morning has already brought some rather revealing economic news from the Euro area. As the ECB has told us this.
Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, was -5.2% in April, compared with -4.2% in March
For newer readers narrow money supply measures impact the economy around 3/6 months ahead. The message here is quite simple in that the brakes have not only been applied, but also jammed on. This is a feature of the claims and indeed at times boasts about this.
We covered a lot of ground in the last nine months [prior to today’s meeting], moving from minus 50 basis points to plus 300 basis points. We are continuing this hiking process. As I said, this is a journey. We have not arrived yet.
That was from ECB President Lagarde at the latest press conference when another 0.25% increase in interest-rates was announced. If we look back to last July when the first interest-rate rise was announced we see that the annual rate of M1 growth was 6.8% and as it is now -5.2% we see that one thing interest-rate rises can do is reduce the rate of growth of the money supply. Indeed the size and speed of the moves has sent annual growth sharply negative.
In fact the ECB decided to reduce monetary growth by another more direct route and will increase that this summer.
The APP portfolio is declining at a measured and predictable pace, as the Eurosystem does not reinvest all of the principal payments from maturing securities. The decline will amount to €15 billion per month on average until the end of June 2023. The Governing Council expects to discontinue the reinvestments under the APP as of July 2023.
We know from the other side of the coin ( QE bond purchases expanding the money supply) that there can be lags in the linkages but we do know that the effect eventually arrived.
We see an example of that if we look at the monthly M1 declines which have gone 140 billion Euros then 135 billion and now 75 billion in April when you might expect April to be larger. But the main theme here is of actual monthly declines in the measure which have given us increasingly negative annual growth numbers. It has also brought the size of the M1 aggregate below 11 trillion Euros.
For those who choose to add inflation to the numbers here then the picture looks even worse as high inflation gets added to the existing decline.
Real M1 YoY (only April data available for 2Q) suggests that GDP should be under pressure in the coming quarters. ( @C_Barraud )
Broad Money
The move in the broader measure M3 was particularly significant for inflation targeters. The theory behind looking at a broad money measure is that it affects the economy ( specifically nominal demand or GDP ) around two years ahead.
The annual growth rate of the broad monetary aggregate M3 decreased to 1.9% in April 2023 from 2.5% in March, averaging 2.4% in the three months up to April.
So if you have an inflation target of 2% then monetary growth at this level would in literal terms give you GDP growth of -0.1%. I am not someone who takes the numbers that literally as the historical evidence shows ebbs and flows but there is a clear trend. To that we can add that the monthly decline in the number continues. We have already seen evidence of that.
the narrower aggregate M1 contributed -3.8 percentage points (down from -3.1 percentage points in March)
But the return of positive interest-rates means that the wider components of the measure which are more likely to be interest bearing will be switched into.
short-term deposits other than overnight deposits (M2-M1) contributed 4.7 percentage points (up from 4.5 percentage points) and marketable instruments (M3-M2) contributed 1.0 percentage points (down from 1.1 percentage points).
Even so we have seen monthly declines in the M3 series of 23 billion Euros then 15 billion and now 27 billion in April. So the total looks set to decline back below 16 trillion Euros with the only real doubt being whether it will be this month or in June.
Being Data Dependent
We were assured of this at the latest ECB press conference.
We will continue to follow a data-dependent approach to determining the appropriate level and duration of restriction.
Yet as you can see they are ignoring the monetary data in spite of claiming to include it.The emphasis is mine.
In particular, our policy rate decisions will continue to be based on our assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission.
On Friday ECB Chief Economist Philip Lane spoke and if you look at his charts they show inflation returning to the 2% target. If we take him literally and add in the monetary data then we would have no economic growth in the Euro area. Should the money supply continue to decline as seems likely then policy is set for an economic contraction.
Business Surveys
At a time of high uncertainty one might switch to such surveys as a gauge. This morning’s official Euro area release backs up the money supply data.
In May 2023, the Economic Sentiment Indicator (ESI) decreased in both the EU (-1.9 points to 95.2) and the euro
area (-2.5 points to 96.5). Also the Employment Expectations Indicator (EEI) declined (EU: -2.2 points to 104.0, euro area: -2.8 points to 104.7)
So a weaker economy and there was better news on inflation developments.
Selling price expectations dropped further in industry, services, retail trade and, to a lesser extent, in
construction
Comment
The money supply data is sending a clear signal to the Euro area. One of declining inflation and economic weakness. But we see this from policymakers.
The 1970s high inflation period holds valuable lessons, says Executive Board member @Isabel_Schnabel on the podcast #ErklärMirDieWelt. Today central banks are more independent, have clearer mandates & focus more on inflation expectations. ( ECB)
It is nice of Dr. Schnabel to remind us of what a failure her focus on inflation expectations has been. In fact such a failure that she finds herself comparing with “The 1970s high inflation” period, which is as bad as it gets for a central banker. Of course, she is hoping that listeners will not realise that.
But the fundamental problem is that she and her colleagues continue to focus on the same models that highlight core inflation, wages, inflation expectations and more latterly claims of tight labour markets. Whereas they apparently are ignoring the money supply measures which warned that inflation was coming over the horizon. So we are now at risk of a central bank created recession after a central bank created inflationary burst. It could be a rough start to 2024 especially if the winter is cold and still.
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Hello Shaun,
ref: ” So we are now at risk of a central bank created recession after a central bank
created inflationary burst”
Just as planned ( Tzeentch )
Forbin
Hi Forbin
I think that much of this is unintentional. The central bankers seemed to dream themselves into a world where all the monetary easing would create only a little inflation. By the time it was obvious even to them that this was a fantasy it was already too late.
I don’t know much about economics, European politics, fiscal and monetary policy, yield curve control, money supply theory, macro economics, eurodollar markets, single market policy, international trade, currency trading, commodities or financial engineering, but I think, why not print some more money?
Hey, have you ever thought of becoming an MP???!!!
I might have said a member of the Bank of England Rate Setting Commitee, but no you are far too qualified.:)))
Good article in the Times on Saturday, referring to the spike in interest rates during the Trussmania debacle last autumn, where the spike was described as “the moron premium” blamed on Truss/Kwarteng, however now UK interest rates are spiking up again it is now the Bank of England’s failure to tackle inflation that is being blamed and they are being described as morons:
“The morons are no longer in the government but at the Bank of England,” one market insider said.
I think it is rather insulting to morons to group them with the likes of Bailey, but there you go. His track record at the FCA should have been enough to prevent him from even getting an interview for the job let alone getting it, but normal procedures don’t apply in those rarified circles do they?
(The article is behind a paywall and I don’t want to copy it as it might drop Shaun in it.)
I am rather dubious on just blaming Truss for the higher IRs.
The B of E had not applied the same increases as the Fed to IRs and indeed went on holiday at the time ( due to the Queen’s death).
To me it was obvious that the B of E would have to put up IRs, regardless of the politicians ideas.
The largest part of the money that Truss wished to borrow was for subsidising the cost of energy – that went through happily once Hunt was in power. So it was not the money that Truss wished to borrow that was the cause of the IR rise.
That leaves me with the conclusion that it was the wish to go for growth, that frightened the politicians and the markets; indeed the Chancellor rising CT to 25% – which most slow growth – merely confirms my ideas!
I also raised my doubts about the reasons and justifications for the Truss/Kwarteng lynching at the time, the absolute relentless hatchet job done by the media also added to the scepticism, as you know when they call in all the attack dogs like that, there is usually a totally different agenda being pursued to that being served up to you.
And as you point out, the current economic damage done by the Treasury and Bank of England is equally disastrous as evidenced by soaring gilt yields and yet absent the article mentioned above, the silence from the mainstream media is deafening.
Great article as always Shaun.
The UK has been like the emperor with no clothes since 2008. The school girl error that Tuss made was pointing out as such.
The UK is a busted flush and can only survive by printing money, no matter which party is in power. But with Truss pulling back the curtain to show the reality, this has destroyed their ability to do so. It was always going to happen, it just happened on Truss’s watch.
This has caused rates to rise higher than they should have been and is threatening the only economy the uk has: selling more expensive houses to each other.
Yes, the ECB is NOW contracting the money supply, but…
https://www.ecb.europa.eu/home/search/coronavirus/html/index.en.html#Helping%20The%20Economy%20Absorb%20The%20Shock%20of%20The%20Current%20Crisis
The problem for the elites was having economic meltdown associated with their covid response (which it damned-well should be), so instead we get stagflation down the line (those pesky Russkies).
Hi therrawbuzzin
This bit is not going so well is it?
“Keeping borrowing affordable”
I notice that in your link ECB President Lagarde was doing some cheerleading for the Euro so here is an ip to date version.
https://www.ecb.europa.eu/ecb/history/25-year-anniversary-of-the-ecb/html/index.en.html