GRAPHIC-Money supply slowdown rings alarm for euro zone shares

Thu Jan 30, 2014 7:27am EST

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* Slower money supply growth may herald euro stocks fall

* M1 indicator tends to lead PMIs, stocks, by 8-12 months

* Indicator peaked in April 2013

By Francesco Canepa

LONDON, Jan 30 (Reuters) - Euro zone equity investors should pay heed to a steep slowdown in money supply growth - history suggests the indicator leads stock markets by around 12 months.

The two diverged last April, when money supply began to fall and stocks kept rising. The latest data has exacerbated the trend, which means equities could be ripe for a steep correction, the following graphic shows:

link.reuters.com/cuv46v

The euro zone's M1 monetary aggregate, a leading indicator of the economic cycle, grew at its slowest pace in two years in December, calling into question a widely held view that the currency bloc is recovering. Investor bets the euro zone is on the mend have helped fuel a 20 percent rally in euro zone shares since June.

The M1 money supply measure includes banknotes and coins as well as deposits that can immediately be converted into cash or used for cashless payments. It tends to lead Purchasing Manager Index surveys of economic activity and share prices by 8 and 12 months respectively, Datastream figures showed.

A decrease in the money supply typically results in higher borrowing costs, which in turn hamper investment and spending.

Last time M1 peaked, in August 2009, euro zone equities began an 18 percent slide eight months later, the data showed.

David Man, a director at RMG Wealth Management, expected weak economic conditions to hamper European shares in coming months.

"Europe as an economy still hasn't recovered properly and still has major risks with it," he said. "At some stage in the first two quarters we're going to see a peak."

(Editing by Catherine Evans)

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