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UK economic news remains reassuring and at odds with the unremitting gloom purveyed by the media and propaganda organisations such as the British Retail Consortium (BRC).

The Monster index of online job vacancies rose by an annual 14% in April, up from 9% in March, despite a fall of 8% in public sector openings. A seasonally-adjusted version of the index tracks combined output of the services and industrial sectors (which account for 93% of GDP) and remains on an upward trend, implying that the economy is continuing to recover despite data volatility caused by the weather, holiday effects and unreliable ONS estimates of construction output – see first chart.

Rising employment is also suggested by last week’s Royal Institution of Chartered Surveyors (RICS) commercial market survey, showing an increase in demand for space in the first quarter – second chart.

The RICS housing market survey for April, released this morning, reported a rise in both activity and price balances. The net percentage of surveyors expecting higher prices remains heavily negative but – at least when asked by their industry body – estate agents have a surprising tendency towards pessimism: the current reading has been associated with inflation historically – third chart.

Reflecting holiday effects, BRC retail sales soared by an annual 6.9% in April, a figure as meaningless as the 1.9% March slump, which was a cause of much celebration by the gloomsters when reported a month ago – see previous post. The average of the current and year-before annual changes strips out holiday distortions and is a better guide to the underlying trend: April’s 3.3% result was in the middle of the recent range, consistent with a subdued but not suicidal consumer – fourth chart.

The OECD’s leading indices for March confirm a loss of global economic momentum suggested much earlier by monetary trends – see January post.

The first chart shows the six-month growth rate of combined industrial output in the G7 and emerging “E7” economies together with a forecasting indicator derived from the OECD indices, which incorporate a wide range of economic and financial inputs. The indicator peaked in December and fell again in March, suggesting that output will slow into the summer, based on the usual 3-7 month lead.

Monetary trends are signalling a slowdown rather than anything worse. G7 real narrow money is still expanding and the lower rate of increase recently reflects higher inflation, with nominal growth boosted by the Federal Reserve’s QE2 securities purchases – second chart. A reversal is possible after QE2 ends at mid-year but this would affect the economy only from early 2012.

Interestingly, the recent decline in the forecasting indicator has been due to the G7 rather than E7 component – third chart. Within the E7, the OECD indices are signalling a slowdown in Brazil, India and Russia but continued strength in China. Chinese resilience, however, is at odds with recent monetary trends and, if correct, implies further policy tightening, which would increase the risk of a “hard landing” later in 2011.

A post in March suggested that commodity markets would cool as emerging-world growth slowed in response to monetary tightening. Industrial commodity prices remain closely correlated with E7 industrial output – see first chart.

The timing of the correction, however, seems partly to reflect central bank liquidity operations. A post last week noted that G7 bank reserves were no longer rising, with the Fed temporarily sterilising its QE2 purchases (by requesting that the Treasury hold more cash in its Fed account) and the Bank of Japan allowing the post-earthquake liquidity boost to unwind. These trends are confirmed by the latest data – second chart.

Commodity bears may need to exercise caution near term since QE2 has yet to complete and the Fed could choose to “unsterilise” its recent purchases if weakness extends to equities and credit markets, resulting in a generalised tightening of financial conditions. For the moment, however, events are probably playing out to the Fed’s satisfaction. Inducing a correction in commodities, indeed, may have been an intention of Chairman Bernanke’s refusal to entertain QE3 speculation at last week’s press conference – consistent with the recent cessation of liquidity injections.



The consensus narrative is that a rise in UK interest rates has been pushed back by “disappointing” economic news. The consensus rate view may be right as the MPC diverges further from its remit but the interpretation of recent economic data is questionable – the balance of news suggests that growth is continuing at or slightly above its trend or potential rate:

• The first-quarter GDP figures released last week imply that output of the industrial and services sectors – which account for 93% of the economy – rose by 0.8% between November and March, or 2.4% annualised. (This comparison removes the distorting effect of December’s bad weather.) The March level was 1.3% above the 2010 average, consistent with output growing by about 2% in 2011.

• Business surveys indicate further respectable growth in services and manufacturing. The PMI services new business index rose to a 13-month high in April and is above its long-term average. The PMI manufacturing new orders index fell sharply but remains consistent with growth and may have been depressed by Japan-related supply disruption and holiday effects. A weighted average of the two indices declined slightly in April but is at a level historically associated with solid expansion – see first chart.

• Capacity utilisation continues to rise in both services and manufacturing, according to the Bank of England agents’ survey, suggesting above-trend expansion.

• The construction sector depressed GDP over the winter but the first-quarter estimate implies a strong rebound in March. Construction is unlikely to act as a major drag for the year as whole, judging from construction new orders, which were 8% above their 2010 average in the fourth quarter.

• Labour market trends are consistent with growth at or above potential, with unemployment stable and aggregate hours worked over December-February 1.1% higher than six months earlier.

• Slumping consumer confidence and downward pressure on real household disposable income may be yesterday’s story. Real income could rebound strongly in 2012, reflecting recent higher pay settlements, a mechanical drop in inflation and further employment gains. The relative performance of retail stocks, which leads consumer confidence, has picked up since the start of April – second chart.

UK broad money growth remains sluggish but is probably consistent with trend economic expansion and a continuing inflation overshoot given a likely further rise in the velocity of circulation, partly due to negative real interest rates.

• The Bank of England’s favoured broad money measure – M4 excluding money holdings of “intermediate other financial corporations”, or M4ex – rose at an annualised rate of 2.1% between September and March compared with 1.2% in the prior six months, continuing the slow post-crisis trend.

• Annualised growth fell from 3.3% to 0.9% between the fourth and first quarters but this was partly due to financial corporations switching cash into foreign currency deposits excluded from M4ex, possibly in (correct) anticipation of sterling weakness. M4 holdings of households and private non-financial corporations (i.e. M4 excluding all financial corporations) rose by 2.6% annualised in the first quarter, up from 0.8% in the fourth.

• Slow broad money growth has not prevented solid expansion of nominal demand and GDP in recent quarters, i.e. the velocity of circulation has risen. Using the official adjustment for the impact of December’s bad weather, GDP grew by 4.7% in the year to the fourth quarter versus a 1.9% rise in M4ex, implying a velocity increase of 2.7%. The economy’s current travails reflect an unfavourable inflation / real growth split rather than insufficient nominal demand.

• The Bank of England has recently acknowledged arguments for expecting velocity to continue to increase (see a box in the February Inflation Report and an article in the latest Quarterly Bulletin), implying that an acceptable M4ex growth rate may now be well below the minimum 5% previously suggested. In the 1970s, when interest rates were last held beneath inflation for a sustained period, broad money velocity rose by 39% over six years, or almost 6% a year.

• Private non-financial corporations continued to repay bank borrowing during the first quarter but it is a stretch to argue that credit contraction is constraining the economic recovery. Companies have increased investment and hiring but have no need to borrow since net free cash flow is at a record high: the corporate financial surplus (i.e. retained earnings minus capital spending) reached 6.2% of GDP in the fourth quarter versus an average of 0.4% since 1963 – see first chart.

• Gilt holdings of banks and building societies fell by £2.4 billion in March but this reflected a large redemption and is unlikely to signal any reduction in underlying demand. Holdings have increased by £28.4 billion over the last five months, more than net gilt issuance of £26.9 billion over this period – second chart.

Global industrial growth has peaked, judging by April manufacturing purchasing managers’ surveys, showing a slowdown in order inflows across the major economies – see first chart.

The global industrial slowdown partly reflects supply chain disruption due to the Japanese earthquake but is also consistent with a peaking of G7 real narrow money growth last summer, allowing for the usual six to 12 month lag between money and the economy. Monetary trends, however, have yet to suggest serious economic weakness: G7 real narrow money is still expanding, in contrast to a contraction before the last recession – second chart.

Slower growth within an ongoing economic upswing would maintain the similarity between the current cycle and the recession / recovery of the mid to late 1970s – third chart. This “template” suggests another recession starting in late 2013, a scenario that would fit with central banks raising interest rates in 2011-12 to curb inflation, allowing for a roughly two-year lag between policy changes and their maximum economic impact.

The risk of an earlier downturn focuses on emerging markets, where monetary authorities have allowed economies to overheat and now face a tough challenge in trying to engineer a “soft” landing. China’s headline PMI new orders index showed little change in April but looks much weaker when adjusted for seasonal effects (i.e. the tendency for orders to rebound after the Chinese New Year holiday) – first chart. Indian monetary conditions, meanwhile, are restrictive, with M1 slowing sharply in recent months and the yield curve close to inversion – fourth chart. (India’s repo rate was hiked by a further 50 basis points to 7.25% today.)

The spring slowdown in global industrial momentum predicted by real narrow money and, more recently, the OECD’s leading indices should be confirmed by April manufacturing purchasing managers’ surveys. The slowdown was beginning before the Great Hanshin earthquake but has been exacerbated by ensuing supply disruption.

The charts show G7 PMI new orders with, respectively, Korean manufacturing expectations and the world earnings revisions ratio (i.e. the net proportion of equity analysts’ earnings estimates that have been revised up since the prior month). Korea is a bellwether of the global industrial cycle while analysts’ earnings revisions partly reflect information on trading conditions received from company contacts. Both indicators suggest an extension of the March decline in PMI orders.

A previous post suggested that a further rise in US bank reserves implied by the Fed completing QE2 would be offset by a fall in Japanese reserves, as the temporary boost from foreign exchange intervention and emergency lending to the banking system unwound. The surge in G7 reserves since early February – a contributor to recent strength in “risk assets” – might, therefore, end before QE2 itself. The Bank of Japan’s liquidity withdrawal, meanwhile, might support the yen.

This scenario seems to be playing out. Japanese bank reserves have fallen by ¥6.0 trillion, or $81 billion, from a peak in late March versus a $95 billion rise in the US from the same date (as of last week) – see chart. The yen’s effective exchange rate has rallied since early April, though partly in reflection of generalised US dollar weakness.

Hopes that the Great Hanshin earthquake would force the Bank of Japan to embark on massive Fed-style QE have been disappointed. A proposal to increase the “asset purchase program” (dominated by collateralised lending to the banking system rather than direct securities purchases) by a modest ¥5 trillion was defeated by eight votes to one at today’s policy board meeting. Japanese reserves may decline further as the sterilisation of last month’s intervention continues and banks’ demand for funds normalises.

The 0.5% rise in GDP in the first quarter is stronger than it looks because of a large drag from the construction sector that should reverse in the current quarter. Outside construction, the economy has continued to recover over the autumn and winter, consistent with labour market data showing a rise in aggregate hours worked.

Key points:

• Combined services and industrial output, accounting for 93% of GDP, rose by 0.8% in the first quarter, more than recouping a 0.4% fourth-quarter loss. Monthly estimates, moreover, imply that March output was 0.3% above the first-quarter average, so the second quarter may record a 0.3% gain even if activity is static between March and June – see chart.

• Construction output fell by 4.7% in the first quarter following a 2.3% fourth-quarter decline, subtracting 0.3 percentage points from GDP growth given its 6% weight (i.e. GDP would have risen by 0.8% if construction activity had remained stable). This reflects carry-over from December’s bad weather disruption, with monthly data indicating a strong rebound in February / March. Construction new orders lead output and reached a new recovery high in the fourth quarter, suggesting that output will, at the least, regain its third-quarter level. A return to this level in the current quarter would boost GDP growth by 0.3 percentage points (on top of the 0.3 point base effect from services / industrial output).

• A reasonable guide to the underlying path of the economy is the 2.0% rise in gross value added excluding North Sea oil and gas production in the year to the first quarter. (The construction distortion is smaller in the year-over-year numbers because activity was similarly depressed by bad weather in early 2010.) This may seem modest but early GDP numbers during recoveries have historically been revised up while trend economic growth may be only about 2% per annum (rather than the 2.35% assumed by the Office for Budget Responsibility).

• The notion that the economy has been growing at or slightly above trend is consistent with a steady rise in aggregate hours worked and an erosion of spare capacity reported in business surveys, including the Bank of England’s agents’ survey.

• Confirmation that the economic recovery remains on track ought to, but may not, prompt the MPC to begin the policy tightening its February Inflation Report implied was necessary to bring inflation back to target over the medium term.