Euro money warning

Figures released by the ECB next Wednesday could show a further slowdown in annual growth of the M1 money stock. Adjusted for consumer prices inflation, such growth could drop to a five-year low.

My chart shows why this matters. It shows that annual real M1 growth is a good lead indicator of annual industrial production growth. If we use a lag of 10 months, the correlation between the two is a hefty 0.68. For example, slowdowns in money growth in 2000, 2007 and 2011 all led to falls in output within a few months.

The post-1997 relationship between the two suggests that real M1 growth of less than 5.2 per cent is associated with annual industrial production growth turning negative within 10 months. With latest figures showing real M1 growing by only 4.4 per cent, this implies that output next June will be lower than it was this June.

One reason for this link between money and growth is that M1 is a measure of easily spendable money – notes and coins plus sight deposits. When companies and households prepare to spend, they shift their wealth into this liquid form. Variations in M1 are therefore a signal of variations in impending spending.

Another reason is that households and companies lack self-control. If they have ready cash, they spend it and if they don’t have it they don’t spend it. To this extent, variations in M1 are a cause of variations in spending.

For our purposes, though, this distinction doesn’t much matter. What matters is that monetary growth is warning us of the risk of recession.

Granted, this risk is not imminent. Purchasing managers' surveys next week are expected to report continued growth – although in manufacturing it could be near a two-year low.

This fact, though, is wholly compatible with the fact that there is a lag of a few months between variations in monetary growth and fluctuations in output. Given that there has for years been a close correlation between eurozone output, UK output and UK and European share prices, this should worry us all.