Quantitative easing: time for a break
But there is also plenty of worrying data: the most significant, which was released earlier this week, is that the money supply is growing at a rate that is a little too weak for comfort. This matters hugely as the amount of money in bank accounts or held in cash has a huge impact on the demand for assets (as well, of course, for the demand of goods and services).
The Bank of England’s favoured money measure – M4 excluding money holdings of “intermediate other financial corporations” – grew at an annualised rate of only 3.7 per cent during the second quarter. Just as worryingly, growth in the first quarter was revised down from 6.2 per cent annualised to 3.3 per cent. A healthy rate would be around 8 per cent at this stage of the cycle.
Without quantitative easing – which may or may not be extended today – the growth rate would have been even weaker. Before we panic too much, however, we should look at the real rate of growth of the money supply, after adjusting for inflation. Real M4 growth – adjusted by the retail prices index – has recovered from a low of -0.7 per cent in the third quarter of 2008 to 4.7 per cent by the second quarter. The problem, however, is that the retail price index measure of inflation is about to recover significantly – and that means that the money supply will have to accelerate drastically to keep up.
The Bank’s measure is imperfect as it excludes assets that are in fact highly liquid and close substitutes to money. Simon Ward, economist at Henderson New Star and an expert in this area, produces what I think is by far the best liquidity measure. It includes Treasury bills and repo borrowing by the Debt Management Office (a close substitute for bank repos included in M4); this broader gauge has risen by a healthier 5.2 per cent annualised so far this year. That is certainly better, though still a tad weak. And there can be no doubt that when retail prices bounce back, the real increase in liquidity will be squeezed yet further.
On balance, however, I still think that the Bank of England should wait and see before extending quantitative easing. There are plenty of signs that the economy is doing less badly. My second favourite economic indicator – after the money supply, that is – is the services sector purchasing managers index. It jumped to a reading of 53.2, up from 51.6; any number above 50 suggests a return to growth. That is especially good for London and the South East, which are totally dependent on services – but in fact services are the biggest source of income in all parts of the UK.
It would also be interesting to see what happens to the government’s massive gilts sales without the Bank’s support. Would yields surge – or is the market so hungry for gilts that it will continue to swallow them without question? That is a crucial question, which would be of great interest to both Labour and the Tories, but which can only be answered when the Bank stops snapping up gilts as fast as Alistair Darling can print them. Time for a break from quantitative easing.