Changes in household energy bills will cut 1.6 percentage points (pp) from UK annual CPI inflation between September and October, implying a drop from 6.7% to 5.1% if annual rates of increase of other components are unchanged. Slowing food prices promise to lop a further 1.5 pp off annual inflation by early 2024, both directly and via pass-through to the important catering services component. So a minimum expectation is that the headline rate will be back at about 3.5% by next spring, before allowing for likely moderation in other inflation components.

The energy bill effect in October reflects the dropping out of a 25% increase in October 2022 along with a 7% cut in the price cap this month. The annual rate of change will swing from 6% in September to -22%. A simple calculation would suggest a 1.3 pp impact on headline CPI inflation, i.e. the 28 pp swing multiplied by a published weight of 4.8%. It turns out that the actual impact is larger because of the way that monthly price changes have interacted with variations in the weight due to relative price movements and basket revisions.

Annual inflation of food, beverages and tobacco has moderated but was still up at 11.8% in September. The CPI measure tracks the corresponding PPI component, annual inflation of which is now below 5% (4.5% in September) – see chart 1.

Chart 1

A fall in annual inflation of the CPI food measure to 5% by early 2024 would suggest a 1.1 pp impact on the headline rate, i.e. the 6.8 pp fall from the September multiplied by a published weight of 16.1%*.

As the chart shows, however, food prices are also a key driver of the catering services component, which has a 10.9% weight. The beta of this component to food prices has been about 0.5 historically, i.e. the suggested fall of 6.8 pp in annual food inflation would be expected to lower catering services inflation by 3.4 pp, cutting a further 0.4 pp from the headline rate.

Central bankers and commentators worried about sticky services inflation underestimate the pass-through effects of energy and food prices. Catering services accounts for 23.4% of the services basket, so the suggested 3.4 pp drop in the annual increase would cut 0.8 pp from annual services inflation (6.9% in September).

The above analysis also applies to the Eurozone, although the estimated impacts are smaller because annual inflation of food, beverages and tobacco is lower than in the UK, i.e. 8.8% versus 11.8% in September.

As in the UK, a slowdown in the corresponding PPI component suggests a fall in annual food inflation to 5% soon – chart 2. A 3.8 pp reduction would imply a 0.8 pp cut in headline inflation, based on a 20.0% weight.

Chart 2

Eurozone catering services inflation also has a beta of about 0.5 to food prices, so could fall by 1.9 pp. This would cut a further 0.2 pp from the headline rate and 0.4 pp from services inflation (based on weights of 8.4% and 19.2% in the overall and services baskets respectively).

So the combined direct and indirect effects of the food slowdown on CPI inflation would be about 1.0 pp in the Eurozone against 1.5 pp in the UK.

*As with the energy effect, a detailed calculation yields a slightly larger impact.

This is the second in a series of short posts focusing on whether incoming economic news supports or contradicts the forecast of a global “hard landing” suggested by monetary trends.

The US ISM manufacturing new orders index rose to a 13-month high of 49.2 in September, apparently supporting soft landing hopes.

A post in July flagged the possibility of a near-term rebound but suggested that this would prove to be a “head fake” preceding a move back below 45. 

The main reason for expecting a recovery was that the stockbuilding cycle was judged to be moving towards a low, i.e. a drag on new orders from customer inventory adjustment was likely to abate. 

The reason for expecting the recovery to be brief and followed by a relapse was that US real narrow money momentum remained heavily negative, suggesting that a stockbuilding boost would be outweighed by weakness in final demand. 

Historical instances of ISM new orders recovering through 50 when real money contraction was negative include 1957, 1970, 1980 and 1990. The orders index subsequently fell back below 45, with the relapses associated with recessions – see chart 1. 

Chart 1

Six-month real narrow money momentum has recovered since mid-year but remains significantly negative. 

The earlier suggestion of a recovery in ISM new orders was supported by a sharp rebound in Korean FKI manufacturing expectations between February and July – Korean exports are sensitive to changes in global industrial momentum. FKI expectations relinquished most of the February-July gain in August / September. 

Verdict: inconclusive.

Eurozone / UK CPI momentum continues to normalise in line with the profile of broad money growth two years ago, a relationship suggesting a return of annual inflation to target in 2024 and an undershoot in 2025.

The six-month annualised rate of increase of Eurozone consumer prices (ECB seasonally adjusted measure) was stable at 3.3% in September but core momentum (i.e. excluding energy, food, alcohol and tobacco) posted another hefty fall from 4.0% to 3.4%, the lowest since January 2022 – see chart 1. 

Chart 1

The current rates of increase are consistent with broad money momentum two years earlier: six-month growth of non-financial M3 was still running at about 6% annualised during in H2 2021. 

Broad money growth of 4-5% pa is compatible with the 2% inflation target over the medium term. (The ECB’s “reference value” for M3 growth under the now-demolished monetary pillar was 4.5% pa.) Six-month momentum moved into this range from Q2 2022, suggesting that the six-month rise in prices will return to about 2% annualised around Q2 2024, with annual inflation following later in the year. 

The six-month rate of change of broad money broke decisively below 4% annualised in early 2023, moving into contraction in May. The message is that CPI momentum is on course to undershoot in 2025 unless the ECB reverses policy tightening and generates an early / significant rebound in money momentum. 

The six-month annualised rate of increase of UK seasonally-adjusted consumer prices slowed sharply in August but was still above the Eurozone level, at 4.4% versus 3.3% – chart 2. UK and Eurozone six-month broad money growth was identical in August 2021 (6.1% annualised) but earlier strength had been more extreme in the UK, possibly contributing to higher current inflation. 

Chart 2

Six-month broad money momentum, however, fell more sharply in the UK than the Eurozone in late 2021, while the UK increase broke below 4% annualised six months earlier, in July 2022. The suggestion is that the UK inflation decline will catch up with or move ahead of Eurozone progress over the next six to 12 months.

This is the first of a series of short posts focusing on whether incoming economic news supports or contradicts the forecast of a global “hard landing” suggested by monetary trends. 

Flash results suggest that the global composite PMI new orders index – a timely indicator of demand momentum – fell for a fourth month in September, consistent with the monetary signal of a slide into early 2024, at least. 

The flash results, available for the US, Japan, Eurozone, UK and Australia, imply a decline through 50 to the lowest level since December, assuming no change in all other countries in the global aggregate – see chart 1. 

Chart 1

Weakness in the flash surveys was driven by a further slowdown in services new business, with manufacturing new orders little changed – chart 2.

Chart 2

Any hopes of manufacturing stabilisation, however, may be dashed by full September results incorporating China and other emerging economies. The equity analysts’ earnings revisions ratio correlates with Chinese manufacturing PMI new orders and weakened sharply this month – chart 3. 

Chart 3

Renewed deterioration in Chinese / Asian manufacturing is also suggested by the Korean FKI survey for September, showing a relapse in the assessment of business prospects to the weakest since February – chart 4.

Chart 4

Global six-month real narrow money momentum is estimated to have broken to a new low in August, reinforcing pessimism here about economic prospects and casting strong doubt on now widely-held “soft landing” hopes. 

Real money momentum bottomed in July 2022, recovered during H2 but suffered a relapse in early 2023, retesting the 2022 low in April. The relapse has been reflected in a renewed downswing in economic momentum, as proxied by global composite PMI new orders – see chart 1. 

Chart 1

A tentative stabilisation of real money momentum over the summer suggested that PMI new orders would bottom out around year-end. The further move down in August, if confirmed, signals deeper and more extended economic weakness. 

The August estimate is based on monetary data covering 70% the global (i.e. G7 plus E7) aggregate and near-complete CPI results. 

The suggested fall to a new low reflects both additional nominal money weakness and an oil-price-driven recovery in six-month CPI momentum – chart 2. 

Chart 2

The ongoing oil price rally suggests a further near-term rise in headline CPI momentum – chart 3. A core slowdown, however, is expected to continue and may accelerate as higher oil costs squeeze spending on other items. 

Chart 3

The further fall in real narrow money momentum has been driven mainly by China and India – chart 4. An earlier post attributed Chinese monetary weakness to misguided policy tightening in late 2022, which has since been partially reversed. Chinese August money numbers suggest greater damage from the misstep than previously assumed, implying a more urgent need for additional policy easing. 

Chart 4

An August estimate of global industrial output is not yet available but a large negative differential between six-month rates of change of real narrow money and output is likely to have persisted – chart 5. 

Chart 5

As previously noted, global equities have underperformed cash since this differential turned negative in early 2022 (allowing for reporting lags), despite a rally over the last 12 months. 

Why was weakness compressed into the first nine months of 2022, with a subsequent strong rebound? 

One explanation is that the Ukraine invasion and associated immediate further upward pressure on energy prices exaggerated the market response to monetary deterioration. Positioning and sentiment reached oversold extremes in late 2022, creating the potential for a relief rally as energy markets adjusted and prices fell back. 

Another possibility – admittedly difficult to assess – is that the “excess” money backdrop has been less unfavourable than suggested by the six-month momentum differential shown in chart 5, because of the existence of an overhang from the 2020-21 monetary surge. An excess stock of money, in other words, may have persisted despite the flow turning negative. 

The ratio of the stock of real narrow money to industrial output has trended higher over time, with the increase reflected in rising real asset prices and wealth – chart 6. 

Chart 6

A huge overshoot in 2020-21 has been correcting since late 2021 but the ratio was still above its pre-pandemic trend at end-2022, i.e. the negative flow differential had not fully offset the prior period of excess.

The stock and flow signals, however, are now aligned: the real money / output ratio moved below trend in early 2023 and its July level was the lowest since February 2020 before the policy response to the pandemic and subsequent monetary surge.

A “double dip” in the global economy suggested by monetary trends appears to be playing out, with weakness likely to intensify into late 2023. 

The global composite PMI new orders index – a timely coincident indicator – continued its decline from a May peak last month. A relapse had been suggested by a fall in six-month real narrow money momentum from December 2022 – see chart 1. 

Chart 1

The year-to-date low in real money momentum occurred in April but there was little recovery through July and another decline is possible. The suggestion is that the PMI will fall further into Q4 and remain weak into early 2024. 

As expected, the composite PMI fall is being driven by services converging down towards weak manufacturing – chart 2. The August decline in services new business reflected a plunge in demand for financial services and a further consumer slowdown, with a partial offset from a minor recovery in business services after a larger July drop – chart 3. 

Chart 2

Chart 3

The ending of the services mini-boom, which fuelled recent employment gains, suggests a faster loosening of labour markets. Unemployment rates have reached 12+ month highs in the US, France, the UK and Canada, while a rise appears to be under way in Japan – chart 4. 

Chart 4

Previous posts suggested that a bottoming out of the stockbuilding cycle would support manufacturing new orders later in 2023. The cycle downswing, however, could be extended by delayed inventory cut-backs in the Eurozone: stockbuilding bounced back in Q2 as final demand contracted sharply, with recent adjustment lagging far behind the US / UK – chart 5. 

Chart 5

Eurozone / UK July money numbers offer further support to the assessment here that ECB / Bank of England policy tightening has been excessive and – unless reversed swiftly – will cause unnecessarily severe economic weakness and a medium-term inflation undershoot. 

The latest releases are astonishing in several respects. 

Six-month real narrow money momentum hit a new low in the Eurozone in July and is even weaker in the UK despite a recent boost from falling six-month CPI inflation. Readings are much worse than elsewhere and historically extreme – see charts 1-3. 

Chart 1

Chart 2

Chart 3

Broad money has followed narrow into nominal contraction. The preferred broad measures here, i.e. Eurozone non-financial M3 and UK non-financial M4, fell at annualised rates of 0.8% and 0.9% respectively in the three months to July – charts 4 and 5. 

Chart 4

Chart 5

Broad money declines are rare: since 1970, the Eurozone / UK three-month changes were negative only for a brief period around the GFC, with the falls of similar magnitude to recently. 

Money leads the economy while credit is coincident / lagging. Bank lending to households and non-financial firms is starting to contract, consistent with recessions being under way – charts 4 and 5. 

A further notable feature of the Eurozone data is a widening divergence between still-rising bank deposits in Germany and falls elsewhere – chart 6. 

Chart 6

A similar core / periphery monetary divergence in 2011 warned of an escalating Eurozone crisis. The driver then was capital flight from the periphery, reflected in a ballooning of national central bank TARGET deficits / surpluses. 

The Bundesbank’s TARGET surplus has fallen recently. Rather than capital flows, the relative resilience of German broad money is explained by less pronounced weakness in bank lending – chart 7. 

Chart 7

So money / credit trends suggest that economic prospects in the rest of the Eurozone are at least as bad as in Germany. 

Eurozone six-month CPI momentum, meanwhile, continues to track a simplistic monetarist forecast based on the profile of broad money growth two years earlier – chart 8. Six-month headline momentum was unchanged at 3.3% annualised in August but core slowed further to 4.0%, a 17-month low. 

Chart 8

The suggestion is that six-month headline momentum will reach 2% next spring, with the annual rate following during H2. A subsequent significant undershoot is indicated unless recent monetary weakness is reversed.