LONDON (Thomson Financial) - The European Central Bank today said that M3 money supply in the euro zone remains strong but warned that the elevated annual rate could be misleading.
"Over the course of 2006 and in early 2007 developments in the annual growth rate of the broad aggregate M3 may overstate the dynamism of the underlying rate of monetary expansion," the ECB said in an article published in its monthly bulletin today.
High levels of money supply growth has often been cited as a key reason for lifting interest rates in the 13-nation single currency area.
The ECB article identified a number of reasons why M3 growth may rise even as short-term interest rates increase.
Firstly, a higher demand for money may emerge for portfolio management reasons, as investors switch out of assets such as bonds and move into time deposits, money market funds or short-term debt securities.
At the same time, higher short-term interest rates have led to a flattening of the euro area yield curve, and in turn increasing the attractiveness of short-term time deposits compared with longer-dated assets. "The former offer the same yield as the latter, while having more liquid characteristics."
Additionally, higher interest rates and the improved economic outlook may encourage inflows of capital into the area, which may also serve to raise M3 growth.
"Each of these three elements has played some role in explaining the strengthening of M3 growth since December 2005, when key ECB interest rates started to rise," the article said.
At last count, Euro zone M3 money supply grew by an annual rate of 10.7 pct in May, up from a 10.4 pct in April.
Last week ECB president Jean-Claude Trichet said that continued vigorous money and credit growth suggests upside risks to price stability in the medium and longer term.
"Monetary developments continue to require very careful monitoring, particularly against the background of the expansion in the economic activity and still strong property market developments," he said.
Still Trichet did concede there is evidence in some components of the M3 data that ECB rate rises are starting to have an impact on money and credit growth.
sivakumar.sithraputhran@thomson.com
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