Higher undergraduate tuition fees are likely to raise the consumer prices index by about 0.6% over the three years from October 2012, implying a boost of 0.2 percentage points to annual CPI inflation. The CPI rise may inflate public sector net borrowing by about £2.2 billion by 2015-16, mainly reflecting higher inflation-linked benefits. This would wipe out two-fifths of the gain to the public finances from the increased fees.

Based on recent announcements, Research Fortnight is forecasting average headline tuition fees of £8600 in England in 2012-13, or £8200 taking into account waivers. The latter figure represents a 143% increase on the maximum chargeable fee of £3375 in 2011-12.

The CPI weight of undergraduate fees paid by UK and EU students is about 0.45% so a rise of 143% would boost the index by about 0.6% (0.65% to two decimal places).

The fee increase applies to first-year students in 2012-13 and second- and third-year students in 2013-14 and 2014-15 respectively. The CPI effect, therefore, will be staggered over three years, with successive rises of about 0.2% in October 2012, October 2013 and October 2014.

The tuition fee boost to the CPI will have a negative impact on the public finances, mainly by increasing spending on inflation-linked benefits, tax credits and public sector pensions. An estimate of this indexation effect can be derived from Office for Budget Responsibility (OBR) research on the fiscal implications of oil price fluctuations. The OBR has estimated that a permanent £10 per barrel rise in the oil price boosts the CPI by 0.25% while increasing borrowing by £0.9 billion per year by 2015-16 as a result of indexation (see Economic and fiscal outlook, March 2011, p.111). This suggests that a 0.6% rise in the CPI due to higher tuition fees would raise 2015-16 borrowing by £2.2 billion.

The OBR has also estimated that the rise in tuition fees will increase higher education funding by £5.6 billion per year by 2015-16 (see Economic and fiscal outlook, November 2010, p.89). The boost to inflation-linked spending, therefore, could absorb 40% of the additional resources created by the higher fees.

Government plans, in effect, involve transferring £2.2 billion per year by 2015-16 from students to benefit recipients and public sector pensioners, whose incomes are linked to the CPI but who do not pay tuition fees. This makes little sense. Instead, benefits and pensions should be uprated by the CPI excluding tuition fees, with the resources released used to cut borrowing or increase the direct allocation to higher education.

The monetarist rule is that the (real) money supply leads economic activity by between six months and a year. This rule has worked well in recent years: G7 real narrow money contracted in late 2007 before the recession but surged in late 2008 ahead of the economic recovery from spring 2009.

G7 real money expansion fell back temporarily around the end of 2009 but rebounded to a peak last summer. This pick-up has been reflected in a strong global economy in early 2011. Real money, however, has continued to slow in recent months. Based on the monetarist rule, therefore, global growth should lose momentum from the spring.

Other evidence is starting to confirm this scenario. The chart shows the six-month growth rate of combined industrial output in the G7 and emerging "E7" economies together with a forecasting indicator based on the OECD's country leading indices, which incorporate a wide range of economic and financial inputs. The indicator usually leads turning points in output expansion by between three and seven months and has fallen since December, suggesting a growth peak between March and July.

In contrast to late 2007, real money expansion and the leading indicator remain positive – they are not signalling major economic weakness, let alone the dreaded "double dip". Directional changes in the indicator, however, tend to be sustained so a further decline is likely over coming months, in turn implying that the economic slowdown will extend into late 2011.

Importantly, the fall in G7 real money growth has been due to rising inflation rather than a slowdown in nominal monetary expansion. It does not, in other words, reflect any tightening of policy by the G7 central banks. Without policy restraint, inflationary pressures are likely to remain elevated. The outlook, therefore, is for slower economic growth but limited relief on inflation – an unappealing "stagflationary" prospect for markets.

Construction output bounced back strongly in February after weather-related weakness in December and January but the sector is still likely to act as a significant drag on the first-quarter GDP estimate released later this month. There should, however, be a corresponding boost to the second quarter.

Construction accounts for 6% of GDP. Output is estimated to have risen by a seasonally-adjusted 8% in February from an upwardly-revised January level but was still 9% below the fourth-quarter average and 14% lower than in November, before the snow struck. It seems reasonable to assume that the November level will be regained in March or April – construction new orders rose by 18% between the third and fourth quarters and surveys suggest that weakness was temporary. Assuming a March return and stable output thereafter, construction would subtract 0.4 percentage points from GDP growth in the first quarter while adding 0.8 points in the second.

The rest of the economy may grow by about 0.75% in the first quarter, assuming modest further gains in services output in February and March and a reversal of the February decline in industrial production. The construction effect would then imply GDP growth of 0.3-0.4%. This shortfall would be offset in the second quarter. If non-construction output rose by a further 0.5%, GDP expansion would increase to 1.3%, based on the above assumptions.

The Monetary Policy Committee kept Bank rate unchanged at 0.5% despite evidence that the medium-term inflation outlook has deteriorated since the February Inflation Report.

That Report itself signalled a need for policy tightening, forecasting above-target inflation of 2.5% in two years' time if interest rates were held at 0.5%. The alternative projection based on market interest rate expectations was in line with the target but assumed that Bank rate would average 0.7% during the second quarter, implying a quarter-point increase in April or May.

Since February, actual inflation has again overshot the Bank's projection while commodity prices are now stronger and sterling weaker than assumed in the Report. The Bank's first-quarter inflation attitudes survey showed a rise in medium- as well as short-term inflationary expectations and wage settlements have moved up to an average 2.6% in the three months to February, versus 1.5% a year ago, according to Incomes Data Services.

Economic news has been mixed but not obviously softer than implied by the February forecast. First-quarter GDP could be held back by carry-over weakness in construction output following December's bad weather but construction orders and surveys suggest a strong rebound (February output is released tomorrow). Services activity has recovered solidly in early 2011 while private-sector labour demand continues to firm, judging from hiring intentions and online vacancies.

The news since February, therefore, argues for a further upward revision to the Bank's inflation forecast, which was already barely consistent with the target. The MPC's continued inaction is, at least to this author, baffling. The Bank, it seems, is prioritising supporting growth and assuming that this objective can be traded off against higher inflation. Such an approach is both misguided and in conflict with its inflation-targeting remit.

The Japanese stock market has underperformed the World index by 16% year-to-date, incorporating currency moves, according to MSCI – see first chart. Continental Europe has been the best performer closely followed by Canada, in both cases partly reflecting currency strength.

Unless they hedged, investors who rushed to add to Japan in the immediate aftermath of the earthquake have been hit by a sharp fall in the yen, following G7 "concerted" intervention (apparently involving minimal use of foreign official funds) and a large injection of liquidity by the Bank of Japan – second chart. Bank reserves at the central bank surged from ¥14.7 trillion on 10 March, the day before the earthquake, to ¥36.5 trillion on 25 March.

This liquidity boost, however, has taken the form of an increase in net lending to the banking system rather than Federal Reserve-style QE. The Bank of Japan has raised its asset purchase programme by only ¥5 trillion, with buying to be spread over more than a year, implying a monthly rate of about ¥400 billion or $5 billion – the Fed, by comparison, is expanding its securities portfolio by $15-20 billion per week.

The Bank may be reserving its ammunition but the statement issued after today's policy meeting does not suggest imminent radical action. The recent liquidity injection, therefore, is likely to reverse as conditions normalise and banks' emergency demand for funds falls back. This process may be under way, with bank reserves down by ¥3.9 trillion from their peak, and may lend support to the yen and, by extension, relative Japanese equity performance.

The "MPC-ometer" predicted an average interest rate vote of +14 basis points in March, up from +8 bp in February and just above the +12.5 bp threshold suggesting a rate increase – see previous post. In the event, the average vote was unchanged at +8 bp (counting Adam Posen's QE2 proposal as equivalent to a 25 bp rate cut).

The March minutes reveal that wavering members were concerned about economic weakness and unconvinced that inflationary expectations were becoming detached from the target. More recent news on these issues has been mostly hawkish.

Services and industrial output – accounting for 93% of GDP – rose strongly in January to stand 0.7% above the fourth-quarter level. The services recovery is more than a temporary bounceback, judging from upbeat business surveys – not just today's PMI but also the EU Commission business / consumer services survey released last week and yesterday's CBI financial services poll. GDP was held back in January by a further fall in construction output but this reflects carry-over from December's bad weather disruption and should be reversed.

On inflation, the Barclays survey reported a further rise in both short- and longer-term inflationary expectations in the first quarter, confirming the Bank of England's own poll (to which the MPC had early access at its March meeting). CPI and RPI figures again exceeded the consensus forecast in February, business survey pricing plans remain strong while pay settlements averaged 2.6% in the three months to February, up from 1.5% a year before, according to research firm Incomes Data Services.  

Policy shifts abroad could be a key factor tipping the MPC towards tightening. As of yesterday, sterling's effective rate had fallen by 1.9% from the starting level assumed in the February Inflation Report, partly as a result of the ECB signalling an interest rate increase despite seemingly lesser inflation difficulties than in the UK. Recent strong US economic news could result in the Federal Reserve also shifting tack, risking a further slide in the pound with attendant inflationary implications if the MPC continues to stand pat.

The MPC-ometer has moved further in a hawkish direction this month, predicting an average interest rate vote of +16 bp, consistent with six members favouring an increase (assuming that Andrew Sentance continues to vote for 50 bp while Adam Posen maintains his dovish dissent). It must be admitted, however, that MPC communications have not suggested an imminent change in the current stalemate while proximity to the Budget may incline some members towards further delay.