The OTM (outright monetary transactions) program is stuck on the slipway due to Spain’s political agenda but ECB President Draghi is already winning the battle to stabilize the EZ (EuroZone) economy and financial markets. Narrow money M1, comprising physical cash and overnight deposits, surged by a further 1.7% in August, for a three-month gain of 3.4% or 14.1% annualised. Six-month real M1 expansion (i.e. deflated by consumer prices, seasonally adjusted) rose to 3.2%, the highest since February 2010 and a level historically consistent with solid subsequent economic growth – please see the first chart.
Real M1 accelerates before economic upswings as households and firms shift their money holdings into more liquid form ahead of a rise in spending. It is more reliable than real broad money M3, which failed to signal the 2008-09 recession, as well as bank lending to the private sector. Consensus commentary ignores M1 and will probably interpret the August numbers negatively, since M3 rose by only 0.2% on the month while lending was unchanged.
M1 is reviving in response to President Draghi’s campaign to reverse disastrous Bundesbank (BuBa)-inspired monetary policy tightening in 2010-11. Repo rate cuts, liquidity injections, looser collateral rules and zero interest on banks’ excess reserves have combined to reduce three-month euro LIBOR from 1.5% in November 2011 when President Draghi entered office to 15 basis points – below US dollar and sterling rates of 35 bp and 60 bp respectively.
The country breakdown of real M1 (i.e. overnight) deposits shows a further pick-up in six-month growth in the core while the rate of contraction in the periphery has slowed – please see the second chart. A recovery in core activity should restore EZ-wide economic expansion in early 2013 but the periphery will remain stagnant at best, although recessionary pressures should ease.
Hopes of a lasting break in the crisis rest on a resumption of real money expansion in the periphery to lay the foundations for economic recovery. With capital flight apparently stopped, the six-month change in real M1 deposits could feasibly turn positive by October. Such a scenario, of course, requires governments – in core as well as peripheral countries – to proceed with agreed plans, along with President Draghi’s continued success in suppressing BuBa’s opposition to monetary largesse.
