(Bloomberg) -- The UK’s broad money supply contracted for the first time in at least 13 years in August, a signal that monetarist economists are warning is a harbinger of recession.
Monetarists foresaw the double-digit inflation in the UK after spotting a surge in the money supply during the pandemic. Now, these economists are warning that a collapse in the data suggests the UK is heading into recession and a rising risk of deflation.
M4 excluding intermediate other financial corporations — a closely watched measure of money supply — fell 0.6% in August compared with a year earlier after it stopped growing the previous month.
The Bank of England has pushed back strongly against claims by monetarists that it missed vital clues in money supply data. The data is read by these economists as suggesting that the central bank may have already overtightened policy after it halted its interest-rate hiking cycle earlier this month.
The ideas of monetarist economists — such as Simon Ward, economic adviser to Janus Henderson, and Tim Congdon, founder of the Institute of International Monetary Research and a former adviser to Margaret Thatcher — were highly influential in the 1980s and have seen a revival in interest after the recent bout of high inflation.
Former BOE Governor Mervyn King has warned that the central bank is ignoring money supply indicators again, risking a recession.
Ward is reading the current trends in the money supply data as a likely sign of a recession ahead
“Broad money last contracted on an annual basis in 1956,” he said. “Recent weakness has more than offset the 2020-21 surge, with the ratio of broad money to nominal GDP now below its pre-pandemic trend.”
Ward said that a fall in the money holdings of non-financial corporations over the past 12 months is particularly concerning and suggests a “squeeze on profits and likely cut-backs in investment and hiring.”
It was the first time money supply growth has turned negative in the monthly data that goes back to 2010. Quarterly data stretching back to 1998 also shows money supply continuously growing, but there was a sharp slowdown to 0.6% in the second quarter.
The BOE’s deputy governor, Ben Broadbent, has dismissed the criticism over ignoring signals from the data.
“Certainly the very strongest claims – that quantitative easing inevitably leads to rapid growth of commercial bank deposits (M4), on a par with that in the central bank’s balance sheet; and that this, in turn, inevitably leads to excessive inflation – are not well supported by the evidence,” he said in April.
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