Eurozone Money Numbers: Economic Recovery Reflects "Dishoarding"

Eurozone monetary trends are judged here to be consistent with a continued but sluggish economic recovery in early 2014.

Consensus commentary is likely to view October numbers as poor, since the annual rates of change of broad money M3 and loans to the private sector* fell – from 2.0% to 1.4% and -1.6% to -1.7% respectively. Narrow money M1, however, has far superior forecasting properties and continues to expand respectably – by an annual 6.6% in October versus 6.7% in September. The shorter-term trend, moreover, is stronger – M1 rose by 1.0% in October alone and by 1.9%, or 7.8% annualised, in the latest three months.

ECB research** has identified real (i.e. inflation-adjusted) non-financial M1, comprising holdings of households and non-financial firms, as the best monetary leading indicator of the economy. Six-month growth of this measure has eased since May but remained solid at 2.9%, or 6.0% annualised, in October – see first chart. 

The interpretation here is that weak credit supply and demand are continuing to depress lending and broad money but this is not preventing an economic recovery because households and firms are mobilising existing monetary resources to increase spending. Such “dishoarding” is a response to low interest rates and increased confidence in financial stability, and is being reflected in an ongoing transfer of funds out of time deposits and notice accounts into M1.

Deflation worries, accordingly, are exaggerated. Current low inflation is mainly the consequence of monetary restriction in 2011, when the ECB raised official rates despite weakness in both M1 and M3. Stronger M1 growth in 2012-13 suggests that inflation will stabilise and firm in 2014-15. Downside risk stems not from domestic monetary conditions but from upward pressure on the euro / dollar exchange rate, caused partly by the Federal Reserve reneging on its commitment to taper QE.

The country breakdown of M1 deposits continues to show slower real growth in the peripheral grouping (i.e. Italy, Spain, Greece, Portugal, Ireland) but September weakness was partially reversed last month – second chart. Italy / Spain are lagging Germany / France, although divergences are small by the standards of recent years; growth, by contrast, is strong in the three IMF bailout countries – third chart.