Record bank lending – inflationary pressures remain

Not since I began working in the City in the mid 1980s can I remember seeing an economic data release come out so many billions higher than market expectations. Yesterday morning, it was announced that so-called M4 lending, which is the amount of money in loans that is pumped out by banks, jumped to a new record of £31.7bn in January. A survey of economists had predicted a figure of £11.8bn – that’s a difference of £19.9bn! To put this figure in perspective, M4 lending in January was larger than in the whole of 1994. Yesterday the Bank of England also announced that M4 money supply growth, which is the broadest measure of UK money supply including notes and coin in circulation and bank deposits, rose 13% from a year earlier, ahead of the 12.7% survey prediction and only slightly below the 16 year high of 14.4% that was reached last autumn.

Gilts were marginally damaged by these figures, but why did the bond market not sell off by more? Two answers spring to mind – firstly, complacency; and secondly, the focus on money supply is nowhere near as strong now as it was a couple of decades ago, when the government used to target the money supply in an effort to control inflation.

There is no doubt that in the long run, increases in money growth are more often than not associated with increases in inflation. One of Milton Friedman‘s two most famous quotes was that “inflation is always and everywhere a monetary phenomenon” (the other quote being “there is no such a thing as a free lunch”, which is something I don’t entirely agree with!).

The Bank of England recognises this link between money supply and inflation, since contained within the last inflation report were the words “strong money growth may be associated with greater spending on goods and services, or upward pressure on asset prices, posing an upside risk to inflation. To the extent that people recognise this, strong money growth may also prompt them to raise their expectations of future inflation”.

But the extent to which money supply growth causes inflation is the subject of an economic debate that has been raging for centuries. I don’t want to go into this here, although it is definitely worth mentioning that the money supply clearly plays a role in Mervyn King’s mind. In “No inflation, no money – the role of money in the economy” , a paper he wrote while Deputy Governor of the Bank of England in 2002, he concludes:
“My own belief is that the absence of money in the standard models which economists use will cause problems in future, and that there will be profitable developments from future research into the way in which money affects risk premia and economic behaviour more generally. Money, I conjecture, will regain an important place in the conversation of economists.”

If the Governor of the Bank of England cares about money lending and money supply growth, then so do I. Yesterday’s data releases reinforce my view that the Bank of England will have to hike rates twice more, and possibly by more than that.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Richard Woolnough

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