Money Moves Markets

UK recession now odds-on

May 5, 2022 by Simon Ward

Six-month growth rates of UK narrow and broad money – as measured by non-financial M1 / M4 – fell in March. With six-month consumer price momentum rising further, real rates of change moved deeper into negative territory – see chart 1.

Chart 1

Chart 1 showing UK Money / Bank Lending & Consumer Prices (% 6m)

The six-month contraction in real narrow money in March was slightly larger in the Eurozone than the UK – chart 2 – but UK weakness will intensify in April as CPI momentum is boosted further by the rise in the energy price cap . Eurozone six-month CPI momentum, by contrast, eased slightly last month, according to flash data.

Chart 2

Chart 2 showing Real Narrow Money (% 6m)

Expressed at an annualised rate, UK six-month broad money growth was 4.2% in March, close to a 4.5% average over 2015-19 and a pace that, if sustained, would ensure medium-term compliance with the 2% inflation target.

A six-month contraction in real narrow money of the present scale was historically a reliable indicator of future economic weakness but did not always signal a recession.

A recession probability model was previously developed here combining monetary information with a range of other financial variables. Based on end-March data, the model estimates the probability of a recession in 2022 at 70% – chart 3.

Chart 3

Chart 3 showing UK Gross Value Added (% yoy) & Recession Probability Indicator

The probability estimate is derived from an equation for the annual change in gross value added (GVA) including the following variables: real narrow money, real broad money, real broad money held by private non-financial corporations, short- and long-term interest rates, short- and long-term credit spreads, real share prices (FTSE local UK), real house prices and the effective exchange rate. Adjustments were made for the impact of strikes and the 1974 three-day week. The equation was estimated on data up to end-2019 to avoid the covid shock / recession.

The model “explains” the annual GVA change three quarters ahead using current and lagged values of the inputs. The recession probability estimate refers to the likelihood, based on the model, of a negative annual GVA change three quarters ahead, i.e. the 70% estimate refers to Q4 2022. (A negative annual change is a stricter requirement than the conventional recession definition of successive quarterly falls in GDP / GVA.)