“Don’t just do something, stand there!”
Recent UK monetary trends are consistent with a medium-term return of inflation to target, implying that the Bank of England should hold policy even though current inflationary pressures will be slow to fade and the consensus will claim that it is “behind the curve”.
The alternative would be to exacerbate a severe squeeze on real money balances that – on the view here – already guarantees a GDP recession.
Satisfactory inflation performance in the five years before the pandemic was a consequence of low and reasonably stable money growth. Three-month expansion of the preferred broad aggregate here, non-financial M4*, averaged 4.4% annualised, mostly fluctuating between 2% and 7% – see chart 1.
The covid shock arguably warranted policy action to move money growth temporarily to the top of this range. Instead, the Bank’s grotesquely miscalibrated QE programme drove three-month growth to 31% annualised in May 2020. A subsequent sharp slowdown was followed by a rise to a second peak of 15% in January 2021 following an incomprehensible decision to extend QE in November 2020.
Three-month growth, however, has been back inside the pre-pandemic range since July last year – it was 4.2% annualised in April.
Monetary trends have yet to reflect fully recent policy tightening. The April-only numbers hint at further weakness: non-financial M4 rose by only 0.2% on the month, while non-financial M1 was flat.
The latest three-month increase of 4.2% annualised may overstate underlying growth because of retail investors switching out of mutual funds into bank and building society deposits in response to recent market losses. A broader savings measure including National Savings, foreign currency deposits and retail mutual funds grew by an estimated 2.9% annualised in the three months to April**.
A further rise in consumer price momentum, meanwhile, has intensified the squeeze on real money balances. Non-financial M4 and M1 fell by 3.4% and 3.3% (not annualised) respectively in the six months to April – chart 2.
Although three-month money growth has been running at a target-consistent pace for several quarters, the usual “long and variable lag” suggests that a normalisation of inflation may be delayed until late 2023 or 2024.
Economists were last week debating whether Chancellor Sunak’s latest cost of living support package would add to inflationary pressures. The net cost of £10 billion equates to only 0.4% of non-financial M4, i.e. the package won’t shift the dial on monetary trends and, by extension, inflation prospects even if fully financed via the banking system (unlikely).
*M4 holdings of the household sector and private non-financial corporations.
**This assumes zero net purchases of retail mutual funds in April, following net sales in February and March.