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UK recession now odds-on

mai 5, 2022 by Simon Ward

Six-month growth rates of UK narrow and broad money – as measured by non-financial M1 / M4 – fell in March. With six-month consumer price momentum rising further, real rates of change moved deeper into negative territory – see chart 1.

Chart 1

Chart 1 showing UK Money / Bank Lending & Consumer Prices (% 6m)

The six-month contraction in real narrow money in March was slightly larger in the Eurozone than the UK – chart 2 – but UK weakness will intensify in April as CPI momentum is boosted further by the rise in the energy price cap . Eurozone six-month CPI momentum, by contrast, eased slightly last month, according to flash data.

Chart 2

Chart 2 showing Real Narrow Money (% 6m)

Expressed at an annualised rate, UK six-month broad money growth was 4.2% in March, close to a 4.5% average over 2015-19 and a pace that, if sustained, would ensure medium-term compliance with the 2% inflation target.

A six-month contraction in real narrow money of the present scale was historically a reliable indicator of future economic weakness but did not always signal a recession.

A recession probability model was previously developed here combining monetary information with a range of other financial variables. Based on end-March data, the model estimates the probability of a recession in 2022 at 70% – chart 3.

Chart 3

Chart 3 showing UK Gross Value Added (% yoy) & Recession Probability Indicator

The probability estimate is derived from an equation for the annual change in gross value added (GVA) including the following variables: real narrow money, real broad money, real broad money held by private non-financial corporations, short- and long-term interest rates, short- and long-term credit spreads, real share prices (FTSE local UK), real house prices and the effective exchange rate. Adjustments were made for the impact of strikes and the 1974 three-day week. The equation was estimated on data up to end-2019 to avoid the covid shock / recession.

The model « explains » the annual GVA change three quarters ahead using current and lagged values of the inputs. The recession probability estimate refers to the likelihood, based on the model, of a negative annual GVA change three quarters ahead, i.e. the 70% estimate refers to Q4 2022. (A negative annual change is a stricter requirement than the conventional recession definition of successive quarterly falls in GDP / GVA.)