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.