Eurozone – CC&L Financial Group Ltd.

US / Eurozone January money numbers suggest that US policy chaos is damaging economic prospects.

The narrow money measures followed here – US M1A and Eurozone non-financial M1 – were unchanged and fell on the month respectively. Narrow money weakness can reflect reduced confidence and spending intentions.

US six-month real narrow money momentum fell between August and October, partially recovered into year-end but has now returned to the October level – see chart 1. The slowdown since August signalled recent softer economic data – see previous post.

Chart 1

A recovery in Eurozone six-month real narrow money momentum stalled in December / January but the gap with the US has narrowed significantly since August, suggesting better relative performance.

US narrow money momentum may weaken further. Policy chaos may cause spending to be deferred, reducing demand for transactions money.

The Fed has gone on hold with rates judged still to be in restrictive territory. The ECB has cut by more, is still in easing mode and may be closer to “neutral”.

A further consideration noted previously is that US narrow money growth has tended to rise into presidential elections but reverse shortly before or after the poll date – chart 2. (1984 and 2000 were notable exceptions.)

Chart 2

Whisper it softly but Eurozone economic prospects are improving.

Six-month momentum of real non-financial M1 turned positive in October, reaching a three-year high in November. The recovery has been broadly-based across countries, with German momentum slightly above the Eurozone average – see chart 1.

Chart 1

The sectoral breakdown shows that real M1 deposits of both households and non-financial corporations have returned to growth – in contrast to the UK, where corporate narrow money is still contracting, in nominal as well as real terms.

Economic news supports further policy easing. Six-month headline / core CPI momentum is close to target (2.1% / 2.2% annualised respectively in December) and there are signs of labour market softening, including a pick-up in consumer unemployment expectations – chart 2.

Chart 2

The Swiss National Bank started cutting rates in March, three months before the ECB, with the cumulative reduction now 125 bp versus 100 bp in the Eurozone. Swiss six-month real narrow money momentum is stronger and likely to be matched by the Eurozone soon – chart 3.

Chart 3

The UK is lagging because the backward-looking MPC started later with cuts of only 50 bp. A stall in six-month real narrow money momentum from last spring signalled that the economy was heading for renewed stagnation well before the end-October Budget.

Improving Eurozone economic prospects may partly explain a spate of upgrades to corporate earnings forecasts by equity analysts. A positive January revisions ratio contrasts with negative readings in the US / UK and supports the monetary suggestion of a recovery in manufacturing surveys – chart 4.

Chart 4

Eurozone services price momentum is “unsticking” as expected, supporting the forecast of sub-2% 2025 inflation.

A post in September suggested that the ECB staff’s latest inflation forecast – like earlier projections – would be undershot.

With November’s favourable surprise, annual headline and core (i.e. ex. energy and food) consumer price inflation are on course to average 2.2% and 2.7% respectively in Q4, versus ECB September central projections of 2.6% and 2.9%.

Six-month headline / core momentum is still loosely tracking the profile of broad money growth two years earlier, a relationship suggesting a further decline and undershoot of the 2% target – see chart 1.

Chart 1

A fall in six-month core momentum to 2.1% annualised in November was driven by a sharp slowdown in services prices, which fell marginally on the month (ECB seasonally adjusted series).

Previous posts questioned central banks’ focus on “sticky” services inflation. Monetary conditions determine aggregate inflation, with the component breakdown partly shaped by “exogenous” factors. Earlier weakness in energy / food and core goods prices suppressed headline inflation while allowing consumers to spend more on services, delaying price deceleration in that sector. The suggestion was that services disinflation would speed up as downward pressure on goods prices eased.

This appears to be playing out: six-month goods momentum has recovered, mainly reflecting food price reacceleration and a slower fall in energy costs, with the headline impact neutralised by a “surprise” services slowdown – chart 2.

Chart 2

The “monetarist” relationship, taken at face value, implies a period of falling prices in 2025. The judgement here is to downplay this possibility and regard the monetary signal as directional rather than giving strong guidance about the level of price momentum.

The stock of money could still be above “equilibrium”, implying a cushion against deflation. This question can be addressed using the “quantity theory of wealth” – the idea that asset prices and incomes adjust such that a geometric average of wealth and nominal GDP rises in line with broad money over the medium term.

Chart 3 shows that, using Q4 2018 as a base, nominal GDP has lagged broad money significantly while wealth has slightly outpaced it. The nominal GDP / wealth average was still 2% short of the level implied by the money stock as of Q2 2024.

Chart 3

A small “excess” money cushion, along with recent currency weakness, may head off an extreme scenario but money trends still suggest a sustained inflation undershoot and a need for further policy easing to achieve medium-term realignment.

Eurozone money trends are improving but remain too weak to support economic optimism, while country details highlight French stress.

A post in June noted that six-month real narrow money momentum was still significantly negative, suggesting that a minor economic recovery in H1 2024 would give way to a H2 “double dip”. The PMI composite output index fell from 50.9 in June to a flash reading of 48.1 in November.

Six-month real money momentum has risen further since June but was still barely positive in October. It has, however, crossed above Japan and narrowed a shortfall with the US, implying improving relative prospects – chart 1.

Chart 1

Consensus gloom about Germany may be overdone. Six-month nominal narrow money momentum has swung into positive territory since mid-year, catching up with Spain / Italy – chart 2.

Chart 2

French momentum, by contrast, remains negative, with a recovery stalling in September / October.

French narrow money weakness appears to reflect low confidence and spending intentions rather than deposit flight (so far). Annual growth of all bank deposits slowed sharply in September / October but is still on a par with in Germany – chart 3.

Chart 3

France’s deficit in the TARGET system rose by €34 billion in September to a record €175 billion, which could signal a capital outflow related to the political / fiscal crisis. There has, however, been no corresponding increase in Germany’s surplus, for which an October number is available – chart 4.

Chart 4

Monetary considerations argue that the ECB’s latest inflation forecast, like earlier projections, will be undershot.

Annual growth of broad money – as measured by non-financial M3 – returned to its pre-pandemic (i.e. 2015-19) average of 4.8% in October 2022. Allowing for a typical two-year lead, this suggested that annual CPI inflation would return to about 2% in late 2024 – see chart 1. The August reading was 2.1% (ECB seasonally-adjusted measure).

Chart 1

Chart 1 showing Eurozone Consumer Prices & Broad Money (% yoy)

The ECB staff forecast in December 2022 was more pessimistic, projecting annual inflation of 3.3% in Q4 2024. The forecast for that quarter was still up at 2.9% in June 2023 after natural gas prices had collapsed.

Annual broad money growth continued to plunge in 2023, reaching a low just above zero in November, since recovering to a paltry 2.5%. Simplistic monetarism, therefore, suggests that inflation will move below target in 2025 and remain there into 2026 – chart 2.

Chart 2

Chart 2 showing Eurozone Consumer Prices & Broad Money (% yoy)

The September 2024 ECB staff forecast, by contrast, shows inflation rising in Q4 and remaining above 2% until Q4 2025.

The monetarist relationship, taken at face value, implies a period of annual price deflation in H2 2025 / H1 2026. The judgement here is to downplay this possibility and regard the current monetary signal as directional rather than giving strong guidance about levels.

It is possible that the stock of money is still above an “equilibrium” level relative to nominal GDP. The current ratio is below its 2000-19 trend but in line with the 2010-19 trend, and higher than at end-2019 – chart 3. There may still be “excess” money to act as a deflation cushion.

Chart 3

Chart 3 showing Eurozone Broad Money* as % of Nominal GDP *Non-Financial M3

The forecast of a target undershoot requires services inflation – an annual 4.2% in August – to break lower. The price expectations balance in the EU services survey has displayed a (loose) leading relationship with annual services inflation historically, with the current reading consistent with a move down to about 2.5% in H1 2025 – chart 4.

Chart 4

Chart 4 showing Eurozone Services CPI (% yoy) & EU Commission Services Survey Price Expectations Balance