phancock – CC&L Financial Group Ltd.

A further rise in China’s trade surplus over the past year has been accompanied by bumper growth of US dollar deposits in Hong Kong, suggesting that Chinese entities have been building a hedge against RMB depreciation – see chart 1.

Chart 1

US dollar deposits grew by $139 bn or 15.6% in the year to April to stand at $975 bn, equivalent to 4.5% of US M2. They have risen much more strongly than Hong Kong dollar deposits, now representing 92% of the value of the latter, up from 79% at end-2022.

Low inflation has allowed China to gain competitiveness without nominal depreciation, with the BIS real effective rate at a 13-year low – chart 2.

Chart 2

Is demand for US dollar balances starting to wane? The recent fall in Hong Kong rates is consistent with a switch into local dollars. The one-year Hong Kong / US rate differential is the most negative since 2005, before a sustained appreciation of the RMB – chart 3.

Chart 3

Chinese f/x settlement numbers, meanwhile, indicate that the authorities intervened to hold down the RMB for a second month in May. Upward pressure had been signalled by a forward premium on the offshore RMB, which has persisted in June – chart 4.

Chart 4

The onshore spot rate has moved from the weak end to the middle of the PBoC’s trading band, with the central parity rate edging higher – chart 5.

Chart 5

Any signal from the Chinese authorities of acquiescence to an appreciating trend could quickly become self-fulfilling by encouraging a further unwind of hedges, including via a reduced US dollar share of Hong Kong deposits.

Chinese monetary trends suggest a continuation of lacklustre economic growth with negligible inflation.

Six-month momentum of narrow and broad money picked up strongly during H2 2024, raising hopes of a reflationary scenario. Growth rates, however, have fallen back since Q1, to around the middle of ranges in recent years – see chart 1.

Chart 1

May activity numbers confirm an economic slowdown, with six-month growth of industrial output and fixed asset investment falling again, and home sales contracting at a faster pace. Retail sales were boosted by subsidy programmes and promotions, with payback likely – chart 2.

Chart 2

House prices haven’t stabilised. The three-month change in new house prices has stalled below zero, with that for existing homes becoming more negative – chart 3.

Chart 3

Monetary developments don’t yet warrant pessimism. Six-month broad money momentum remains respectable, at 4.0% – 8.2% annualised – in May. This could be consistent with nominal GDP growth of c.6.5% pa, based on a long-run trend rise of 1.75% pa in the money to GDP ratio.

Narrow money momentum has weakened more sharply but the sectoral breakdown is reassuring, showing stable growth of household and enterprise money, with the aggregate slowdown due to a fall in demand deposits of government-related bodies – chart 4.

Chart 4

This fall is unlikely to be a leading indicator of reduced spending by these bodies, particularly as their overall deposit growth – i.e. including time as well demand deposits – has remained stable.

The money numbers, moreover, exclude fiscal (i.e. central government) deposits, six-month growth of which has picked up since Q1. Demand deposits of government-related bodies could recover as funds are transferred to finance spending projects.

The directional signal from UK money growth is that annual core inflation – excluding policy distortions – will fall through end-2025. The level suggestion is that core will undershoot 2%. This suggestion is supported by recent exchange rate appreciation.

Turning points in annual broad money growth – as measured by non-financial M4 – have led turning points in core CPI or RPI inflation by a mean 26 months over the last c.70 years. Chart 1 highlights related troughs (gold dashed lines). (See a previous post for an equivalent chart highlighting peaks.)

Chart 1

The May 2023 core inflation peak occurred 27 months after a money growth peak.

Annual broad money momentum troughed at a 67-year low in October 2023. The mean 26-month lead suggests a core inflation low in December 2025. The median lag at troughs, however, was 29 months, so an inflation low may well occur later.

Core inflation fell sharply in H2 2023 and H1 2024 but has stalled since September. The expectation here is that May numbers released next week will show a decline, possibly to below 3%. (The core measure adjusts for the imposition of VAT on school fees and above-normal increases in water / sewerage charges and vehicle excise duty.)

Annual broad money growth averaged 4.2% in the 10 years to end-2019. Core inflation averaged 1.8% in the 10 years to February 2022 (i.e. allowing for a 26-month lag in the relationship).

Annual money growth moved slightly above 4.2% in late 2024 / early 2025 but dropped back to 3.9% in April. So the levels relationship of the 2010s suggests that core inflation will fall below 2%, with no significant rebound before 2027.

Historical variations in the lag between money growth and inflation – and in the levels relationship – often reflected the influence of the exchange rate.

For example, an inflation decline into 2000 occurred earlier than suggested by monetary trends because of a strong disinflationary impact from a prior surge in the exchange rate: the effective rate rose by 26% in the two years to April 1998 – chart 2. This impact was fading by early 2000, contributing to an unusually short interval between lows in money growth and inflation (six months).

Chart 2

Exchange rate considerations are aligned with the monetary message currently, with a 7% rise in the effective rate in the two years to May suggesting that import prices will remain under downward pressure into 2026.

Eurozone / UK money growth has weakened despite rate cuts, suggesting that central banks – particularly the MPC – have more work to do to sustain economic expansion and prevent inflation undershoots.

Preferred broad money aggregates – Eurozone non-financial M3 and UK non-financial M4 – grew by 2.3% and 2.1% annualised respectively in the three months to April, down from 4.6% and 4.4% in the prior three months – see chart 1.

Chart 1

Concern about the Eurozone slowdown is tempered by still-respectable narrow money growth – non-financial M1 rose by 5.2% annualised between January and April versus 6.2% in the prior three months.

UK non-financial M1, by contrast, contracted by 1.7% annualised in the latest three months, following 6.5% growth in the three months to January.

The slump in UK momentum was driven by a month-on-month fall of 1.0% (not annualised) in April, mostly due to the household component. This may have been related to the end of the stamp duty holiday on 31 March – a bunching of transactions and mortgage borrowing ahead of the deadline may have been associated with a temporary rise in demand for sight deposits, which reversed in April as activity normalised.

An additional possibility is that individuals who sold assets in anticipation of tax rises in the October Budget delayed reinvesting the proceeds until the start of the 2025-26 tax year.

Household broad money rose by 0.2% in April despite the big fall in sight deposits, reflecting a record £14.0 billion inflow to cash ISAs.

Still, the movement of money out of current accounts is a negative signal for the economy, suggesting low spending intentions and a preference for saving.

UK corporate broad money, meanwhile, resumed a decline in the latest three months, suggesting that firms remain under financial pressure to cut jobs and investment.

Global manufacturing PMI new orders – a timely coincident indicator of industrial momentum – fell for a third month in May. The decline from a February peak is consistent with a slowdown in global six-month real narrow money momentum between June and October 2024 – see chart 1.

Chart 1

The PMI fall started slightly earlier than had been expected here. The eight-month interval between the June peak in real money momentum and the February PMI peak compares with an average lag of 11 months at prior turning points since 2015.

Monetary considerations alone would suggest that the PMI will decline further into mid-year before recovering to another local high around end-2025 – the dotted arrows in the chart show a possible path.

The US trade policy shock, however, is likely to impart a negative skew to this profile, as recent demand front-loading reverses and spending decisions remain on hold until tariff uncertainty abates.

Accordingly, the current PMI decline could extend further than indicated with only a minor H2 recovery. Weak April money numbers, moreover, suggest darkening prospects for end-2025 – see previous post.

Global (i.e. G7 plus E7) six-month real narrow money momentum – a key leading indicator in the approach followed here – fell sharply in April, to its lowest level since December. The relapse douses hope generated by a pick-up into March, which suggested a bounce-back in the global economy later in 2025, assuming no further negative “shocks”.

The April fall was driven by a slowdown in nominal money growth to its weakest since November. Six-month consumer price momentum eased slightly further to match its 2024 low (2.0% annualised) – see chart 1.

Chart 1

To recap, a fall in real narrow money momentum between June and October 2024 was expected here to be reflected in a global economic slowdown in Q2 / Q3 2025, which the US trade policy shock will amplify.

Subsequent monetary reacceleration into March held out the hope of an economic recovery in late 2025, by which time negative tariff effects could be starting to fade.

The April money growth fall, however, suggests that a negative feedback loop is developing, with reduced confidence due to US policies resulting in increased risk aversion and a tightening of monetary conditions, despite most central banks remaining on an easing path.

The April decline reflected falls across major economies, reinforcing the negative signal – chart 2.

Chart 2

Economic momentum has been supported by demand front-loading but payback is arriving.

A surge in US goods imports boosted GDP in the rest of the world by 0.25-0.5% in Q1 but April advance numbers suggest a full reversal – chart 3.

Chart 3

Inventory accumulation isn’t just a US story. Stockbuilding as a percentage of GDP rose similarly or by more in major European economies in the year to Q1 – chart 4.

Chart 4

Economic growth depends on the change in stockbuilding, so even a stabilisation at its recent pace would suggest a significant loss of output momentum.