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Job vacancies are a coincident indicator of the economy and a leading indicator of employment and (inversely) unemployment. A 7.7% fall in the outstanding stock in the second quarter was the smallest since a 5.5% decline in the second quarter of 2008, supporting other evidence that GDP contraction slowed sharply last quarter.

The first chart updates a comparison with the last three recessions. The current decline continues to resemble 1989-91 rather than the deeper falls of 1979-81 and 1974-76 (when union power may have constrained layoffs, forcing firms to curb new hiring by more to achieve desired employment levels). Vacancies bottomed 18-24 months after the peak in all three recessions, suggesting that the current fall will end between August 2009 and February 2010.

Other evidence hints at an early trough. For example, the Markit Report on Jobs permanent placements index peaked seven months before vacancies and has been picking up since December, implying a possible vacancies trough in July – second chart. This would be consistent with a stabilisation or small rise in GDP in the third quarter.

(Note: the vacancies statistics for the earlier recessions refer to openings registered at Job Centres. This series was discontinued in 2001 and replaced by a survey of employers.)

Annual CPI inflation fell to 1.8% in June – below the 2% target for the first time since September 2007 – but the figures continue to be flattered by December’s VAT cut. Assuming 60% pass-through, inflation would have been about 2.5% in June in the absence of the reduction. (Note that the “CPI at constant tax rates” measure – which rose an annual 2.9% in June – assumes 100% pass-through.)

The June result benefited from a big decline in annual food price inflation to 5.5% from 8.4% in May. This had been foreshadowed by last week’s producer price numbers, which suggest a further fall – see chart.

“Core” inflation can be measured by the CPI excluding unprocessed food and energy. The annual increase in this measure fell from 2.1% to 1.9% in May but would be about 2.6% without the VAT cut, assuming 60% pass-through.

CPI inflation averaged 2.1% in the second quarter – above the MPC’s 1.9% modal forecast in the May Inflation Report.

Food price inflation has fallen earlier than expected but in other respects today’s numbers are consistent with the forecast presented in a previous post, suggesting that the annual CPI increase will slow to about 1% this autumn before rebounding into 2010. The retail prices index fell by an annual 1.6% in June – the decline may extend to about 2.5% this autumn.

A broad liquidity measure including money-like instruments issued by the public sector has risen at a 10% annualised pace so far in 2009, supporting recovery hopes and justifying the MPC’s caution about expanding the asset purchase facility further. As well as the MPC’s gilt-buying, liquidity has been boosted by increased reliance by the Debt Management Office (DMO) on short-term borrowing to finance the fiscal deficit.

The MPC’s asset purchases are intended to “increase the supply of money directly into the wider economy which should boost spending”, according to the explanation of quantitative easing on the Bank of England’s website. In monitoring the impact, the MPC “will pay close attention to the growth rate of broad money, the cost and availability of corporate borrowing, measures of inflation and inflation expectations, and developments in nominal spending growth”.

The broad money supply is normally measured by M4, which comprises the non-bank private sector’s holdings of notes and coin and a range of sterling-denominated bank instruments including traditional deposits, CDs, securities of up to five years’ original maturity, repos and bills. The aggregate has slowed so far in 2009, rising at a 10.4% annualised rate in the first five months, down from 20.1% during the second half of 2008.

M4, however, has been distorted over the last 18 months by a large increase and more recently a fall in money holdings of financial intermediaries – “intermediate other financial corporations (OFCs)” in the Bank’s terminology – which mainly act as conduits for interbank business. The financial crisis resulted in banks cutting back traditional unsecured interbank lending in favour of secured forms of lending channelled through these intermediaries, facilitated by the operation of the special liquidity scheme.

The MPC is therefore focusing on an adjusted M4 measure excluding these intermediaries’ money holdings. Accurate statistics for this measure are currently compiled only on a quarterly basis but the Bank of England also makes available a “monthly proxy” based on partial information. Combining first-quarter data with proxy numbers for April and May, adjusted M4 grew by 6.8% annualised in the first five months of 2009, up from 3.0% in the second half of 2008.

This adjusted measure, however, understates liquidity growth because it omits the non-bank private sector’s holdings of public-sector financial instruments that are close substitutes for “money” – these holdings have risen substantially over the last year. In particular, Treasury bills and repo borrowing by the DMO are likely to be regarded by investors as having similar characteristics to short-term bank securities and bank repos.

The chart shows annualised growth of adjusted M4 and a broader liquidity measure including holdings of Treasury bills and DMO repos. The growth rates are calculated over six months except for the final data points, which refer to January to May 2009. The broader measure rose by 10.3% annualised over this latter period – much faster than the 6.8% increase in adjusted M4.

In effect, the DMO has been operating its own liquidity creation scheme in parallel with the Bank of England’s asset purchase facility, funding the budget deficit partly by issuing Treasury bills and borrowing on repo rather than selling gilts. The non-bank private sector lent £54.2 billion in these forms in 2008-09 and the first two months of the current fiscal year – equivalent to 28% of the central government net cash requirement over the same period.

A sharp deterioration in money / liquidity trends in late 2007 and early 2008 – particularly after adjusting for inflation – warned of impending economic weakness. The recent pick-up, also more pronounced in inflation-adjusted terms, supports hopes of a recovery from late 2009. It is possible that the MPC is placing some weight on wider liquidity trends, helping to explain last week’s decision to slow asset purchases and defer consideration of a rise in the £125 billion target.

A strong acceleration in global real money supply growth in late 2008 suggested that economic activity would bottom in spring 2009 and recover during the second half – see here and here. Recent news remains consistent with this scenario.

Industrial output in the Group of Seven (G7) major economies fell by 19% between February 2008 and March 2009 but has recovered by 1% by May. This reflects a rebound in Japan, Germany and France, which had suffered more severe declines, offset by a continuing slide in the US, partly reflecting auto sector woes.

Purchasing managers’ surveys show that new orders are stabilising while companies are still cutting stocks. As destocking slows, firms will need to place additional orders with suppliers, who in turn will be forced to raise production. The second-quarter Conference Board Chief Executive Officer survey released earlier this week signals an imminent recovery in US industrial output – see first chart.

The big story of the first half, however, has been the rebound in emerging economies – second chart. Industrial output in seven large emerging economies – the BRICs plus Korea, Taiwan and Mexico – rose by 3% in the six months to May versus a 10% contraction in the G7. Surveys indicate further acceleration.

This “E7” pick-up is not just about China – third chart. Output is on a rising trend in five of the seven economies, the exceptions being Mexico – which will benefit from a US recovery – and Russia. This reflects a rebound in world trade and effective monetary stimulus in economies where banking systems are still functioning normally.

Emerging world strength coupled with improving G7 prospects suggest that a solid “Zarnowitz” recovery in global activity remains possible – see here and here for a discussion. Credit supply constraints in developed economies are not an immediate obstacle to this scenario since credit demand is usually weak in the first year of economic upswings.

There are two key risks. First, labour market deterioration could lead to a further lurch down in consumer spending, aborting the stocks-led industrial recovery. The US June employment report was disappointing but leading indicators give a more hopeful message – for example, the number of job cuts announced last month was the lowest since March 2008, according to outsourcing firm Challenger, Gray and Christmas.

Secondly, real money growth could slow as weak credit trends offset QE and higher commodity prices lift inflation. This is less of a concern in the US and UK – the Fed and MPC are likely to calibrate asset purchases to ensure stability – than the Eurozone, where M3 is stagnant and the effectiveness of the ECB’s QE alternative is in doubt.

There are three possible reasons for the MPC’s decision today to maintain the asset purchase programme at £125 billion, against expectations of an increase.

First, the Committee may judge that the scheme is working as planned and there is no need for a further expansion. Arguments in favour of this view include recent stronger broad money growth and improvements in loan availability reported in last week’s Credit Conditions Survey.

Secondly, and more likely, the MPC is inclined towards an extension but wishes to slow the pace of buying and avoid the impression of an open-ended commitment. The August Inflation Report forecasting round provides a convenient excuse for deferring an announcement, while maintaining the £125 billion cap will automatically cut gilt-buying from £6.5 billion to £4 billion per week.

Thirdly, and least likely, the MPC judges that any positive effects are small relative to possible damage to its inflation-fighting credibility from continuing with the policy.

The absence of any guidance about these alternatives in the MPC’s news release is surprising and may indicate disagreement within the Committee.

A reasonable strategy would be for the MPC to utilise the £25 billion still available under the existing authority in August while spreading purchases over two months, implying a further slowdown to £3 billion per week. Assuming more evidence of positive effects and wider economic improvement, the programme could be suspended at the October meeting.

The MPC’s interest rate cuts have reduced aggregate net interest payments by UK households by 1.8% of their income since the fourth quarter of 2007, according to first-quarter national accounts released last week. This net figure, however, conceals an even larger income transfer from savers to borrowers within the household sector.

Net interest payments peaked at a record 2.2% of gross primary income (i.e. employee compensation plus net property income) in the fourth quarter of 2007 but had fallen to just 0.4% by the first quarter of 2009 – see chart. The 1.8 percentage point decline breaks down into a fall in payments by borrowers of 5.9% of total income, offset by a decline in interest receipts of savers of 4.1% of income.

Expressed in money terms, lower interest rates have given a £60 billiion per annum boost to borrowers’ spending power since the fourth quarter of 2007, financed by a £42 billion cut in savers’ income and an £18 billion loss in the rest of the economy.

Of course, a separation into “borrowers” and “savers” is simplistic because most households have incurred secured or unsecured debt and own some liquid savings. However, it is reasonable to assume that the 32% of households who own their home outright owe little and account for the bulk of savings. (The 32% figure comes from the 2008 NMG Research survey conducted for the Bank of England.)

These wealthy “savers” may also have above-average income. Assuming that they account for 50% of total household income, this would suggest that the group has suffered an income hit of as much as 8% since late 2007 as a result of the collapse in interest rates. On the same rough assumptions, “borrowers” may have enjoyed a windfall of up to 12% of their income.

It might be argued that the income transfer is warranted because mortgage borrowers have suffered a capital loss on their homes. However, this is true only of people who have bought property since 2004 – well under half of borrowers and less than 20% of households. Moreover, savers may have even more wealth tied up in housing than borrowers.

Inflation is often claimed to be bad for savers and good for borrowers. Fear of deflation has had the same effect, by inducing the MPC to reduce interest rates to miniscule levels. The saving ratio has risen recently but this reflects a fall in new borrowing rather than increased financial investment. Savers may understandably feel that the odds are stacked against them.

A previous post used Bank of England effective interest rate data to show that – contrary to the consensus perception – UK banks’ aggregate net interest margin on sterling business remained stuck close to a record low. The margin, however, was expected to improve gradually as high-cost term funding was refinanced at lower rates and banks began to benefit from wider spreads on new lending.

May effective rate statistics released last week are consistent with this story. The average interest rate charged on M4 lending was unchanged on the month, while the average rate paid on M4 deposits declined, mainly reflecting falls on time deposits and notice accounts – see chart. The spread, or net interest margin, therefore rose to its highest level since January.

This may, in fact, understate the improvement in net interest income since banks have also benefited from a falling cost of wholesale funding needed to plug the £490 billion gap between M4 lending and deposits. The spread between three-month unsecured and secured interbank borrowing rates has fallen from 120 to 50 basis points since the start of 2009.

Higher net interest income is needed to provide resources to cover write-offs and support future lending. The current M4 lending / deposit rate spread of 2.1 percentage points compares with an average of 2.8 over 1999-2008. A return to this average would boost UK bank’s pre-tax profits by £14 – 17 billion per annum.

The Office for National Statistics this week revised the fall in UK GDP in the first quarter from 1.9% to 2.4% but monthly figures on output in the services and production sectors – which account for 93% of GDP – indicate that the pace of contraction slowed during the quarter and the economy may have stabilised in April.

The chart shows official quarterly GDP, rebased to the peak level in the first quarter of 2008, together with a monthly proxy based on the services and industrial output data. The proxy was unchanged in April – the first month not to register a decline since September. The monthly numbers are subject to revision but the April reading is consistent with better purchasing managers’ survey results, which improved further in May and June.

The monthly proxy was 0.3% below its first-quarter average in April so the preliminary second-quarter GDP estimate released on 24 July is likely to show a further fall. This should, however, be the smallest since a 0.1% drop in the second quarter of 2008.

Today’s Financial Times contains another downbeat article about the UK’s QE. One fund manager quoted is disappointed that no effect on RPI trends is yet apparent. Since the latest RPI number refers to a period only two months after QE started, while monetary changes typically take two years to have their full impact on prices, this might be considered unsurprising.

Another interviewee correctly links an assessment of the success of QE with money supply figures. Unfortunately, he proceeds to ignore the recent broad money pick-up, referring instead to weakness in bank lending to non-financial corporations. Money and credit are routinely confused in discussions of QE, with few commentators aware that money leads the economy while credit lags.

Contributors to the FT article may not have read the Bank of England’s excellent explanation of the aims and mechanics of QE, available on its website. As well as expanding QE to £150 billion at next week’s meeting, the MPC might consider stepping up its education programme.

Further evidence that QE is beginning to work is provided by the Bank’s second-quarter Credit Conditions Survey released today, showing that a majority of banks made more credit available to mortgage borrowers and companies over the last three months, with a further improvement expected this quarter.

The results of similar surveys in other major economies are usually expressed in terms of the net percentage of banks tightening rather than loosening credit. When the Bank’s survey is converted to the same format, the UK results compare favourably – see chart for corporate lending responses. This reflects the combined impact of QE and lending commitments made by the Lloyds Banking Group and the Royal Bank of Scotland as a condition of their participation in the Asset Protection Scheme. (The UK is the first country to publish a second-quarter survey.)

The Wall Street Journal argues that the ECB’s alternative to QE – supplying banks with unlimited funds on favourable terms – is superior to the Fed’s and Bank of England’s asset purchases on the basis that the effects are similar and the ECB will be able to exit the strategy without causing market disruption.

With due respect, the effects are not similar: the ECB’s banking system loans have no direct impact on the broad money supply and may not even inflate the monetary base. The difference is highlighted by May monetary statistics. While UK broad money has risen at a 6.7% annualised rate so far this year – see yesterday’s post – Eurozone M3 has contracted by 0.8% annualised.

Credit trends are weak in both economies: Eurozone bank lending to the private sector has risen by just 0.4% annualised so far in 2009. In the UK, however, QE has resulted in a large “public sector contribution” to monetary growth – equivalent to 4.9% of the broad money supply in the first five months. With the ECB relying on banks using cheap liquidity to buy government securities, the public sector contribution has been much smaller in Euroland – 0.9% of M3.

Eurozone M3 has also been depressed by a shift of funds into longer-maturity financial instruments to take advantage of the steep yield curve.

Current monetary trends suggest that the UK economy will recover from late 2009 while Euroland continues to flounder.