Global economic news has been generally encouraging during MoneyMovesMarkets' absence, with Asian industrial activity, in particular, rebounding impressively, partly on the back of resurgent Chinese domestic demand.

Today's US second-quarter GDP report continues the hopeful pattern, showing the economy's contraction slowing to 0.3%, or 1.0% at an annualised rate, from 1.6%, or 6.4% annualised, in the first quarter. Stronger net exports and government outlays partly offset further, though smaller, declines in personal consumption and capital spending.

Destocking rose further to 1.1% of GDP in the second quarter, which appears to be a post-war record (based on earlier data – figures released today extend back only to 1995). With final demand stabilising, firms should resist further declines in inventories, implying a significant boost to production during the second half.

Annual revisions show that the recession has been deeper than previously thought, with the fall in GDP by the first quarter of 2009 now put at 3.7% versus 3.1%. However, GDP is still estimated to have peaked in the second quarter of 2008 – at odds with the National Bureau of Economic Research's claim that the economy has been contracting since December 2007.

Recent corporate earnings news is consistent with improving global economic momentum. Equity analysts' revisions ratio, defined as the number of upgrades to 12-month-ahead forecasts minus downgrades expressed as a proportion of the total number of estimates, rose to its highest level since late 2007 last week and suggests further gains in purchasing managers' new orders indices – see chart.

The 0.3% fall in US GDP last quarter compares favourably with a 0.8% decline in the UK, reported last week. The UK figure, however, is difficult to reconcile with business survey results – better in the UK than the US recently – and labour market indicators (see previous post on vacancies). A comparison with initial GDP estimates in prior recessions suggests that the UK numbers will eventually be revised higher – more on this next week.

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Global monetary conditions remain supportive for markets but a further rally in equities could be delayed by rising issuance. Gains also depend importantly on central banks continuing to support money supply growth until private credit expansion revives.

Monetary conditions tightened last year because moderate growth in the G7 broad money supply was insufficient to accommodate higher inflation and a rise in the precautionary demand for money due to the financial crisis. This tightening was evidenced by a contraction in real narrow money M1 – a better measure of cash held for transactions purposes and often more closely related to economic activity and flows into markets.

Conditions began to improve in late 2008 as Federal Reserve asset purchases boosted US broad money, a sharp drop in commodity prices pulled inflation lower and falling economic activity reduced money demand. The emergence of "excess" liquidity was reflected in a strong acceleration in G7 M1 and laid the foundations for both the spring rally in equities and the current incipient economic recovery.

Broad money has slowed again since early 2009, with the impact of "quantitative easing" offset by weak private credit trends. Improving market and economic conditions, however, are likely to have reduced the precautionary demand for money (i.e. the fall in velocity during 2008 may now be reversing). Consistent with liquidity remaining favourable for markets and economies, M1 is continuing to expand faster than broad money.

This positive assessment is subject to two qualifications. First, cash inflows to equity markets could be absorbed by issuance rather than reflected in higher prices. A proxy for the global volume of shares outstanding rose by 1.1% during the second quarter – the biggest gain since the second quarter of 2002. This was influenced by post-stress-test capital-raising by US banks but non-financial companies and banks elsewhere are likely to step up issuance if market conditions allow.

Secondly, monetary conditions could deteriorate if central banks step back from QE efforts before private credit expansion recovers. The Fed's asset purchase plans imply a further significant boost during the second half of 2009 but prospects for the equivalent UK scheme are uncertain, while the ECB's alternative approach of supplying liquidity to banks has yet to yield results. With inflation risks viewed as minimal, however, policy-makers are likely to be open to further "unconventional" actions should credit weakness persist.

Job vacancies are a coincident indicator of the economy and a leading indicator of employment and (inversely) unemployment. A 7.7% fall in the outstanding stock in the second quarter was the smallest since a 5.5% decline in the second quarter of 2008, supporting other evidence that GDP contraction slowed sharply last quarter.

The first chart updates a comparison with the last three recessions. The current decline continues to resemble 1989-91 rather than the deeper falls of 1979-81 and 1974-76 (when union power may have constrained layoffs, forcing firms to curb new hiring by more to achieve desired employment levels). Vacancies bottomed 18-24 months after the peak in all three recessions, suggesting that the current fall will end between August 2009 and February 2010.

Other evidence hints at an early trough. For example, the Markit Report on Jobs permanent placements index peaked seven months before vacancies and has been picking up since December, implying a possible vacancies trough in July – second chart. This would be consistent with a stabilisation or small rise in GDP in the third quarter.

(Note: the vacancies statistics for the earlier recessions refer to openings registered at Job Centres. This series was discontinued in 2001 and replaced by a survey of employers.)

Annual CPI inflation fell to 1.8% in June – below the 2% target for the first time since September 2007 – but the figures continue to be flattered by December's VAT cut. Assuming 60% pass-through, inflation would have been about 2.5% in June in the absence of the reduction. (Note that the "CPI at constant tax rates" measure – which rose an annual 2.9% in June – assumes 100% pass-through.)

The June result benefited from a big decline in annual food price inflation to 5.5% from 8.4% in May. This had been foreshadowed by last week's producer price numbers, which suggest a further fall – see chart.

"Core" inflation can be measured by the CPI excluding unprocessed food and energy. The annual increase in this measure fell from 2.1% to 1.9% in May but would be about 2.6% without the VAT cut, assuming 60% pass-through.

CPI inflation averaged 2.1% in the second quarter – above the MPC's 1.9% modal forecast in the May Inflation Report.

Food price inflation has fallen earlier than expected but in other respects today's numbers are consistent with the forecast presented in a previous post, suggesting that the annual CPI increase will slow to about 1% this autumn before rebounding into 2010. The retail prices index fell by an annual 1.6% in June – the decline may extend to about 2.5% this autumn.

A broad liquidity measure including money-like instruments issued by the public sector has risen at a 10% annualised pace so far in 2009, supporting recovery hopes and justifying the MPC’s caution about expanding the asset purchase facility further. As well as the MPC's gilt-buying, liquidity has been boosted by increased reliance by the Debt Management Office (DMO) on short-term borrowing to finance the fiscal deficit.

The MPC's asset purchases are intended to "increase the supply of money directly into the wider economy which should boost spending", according to the explanation of quantitative easing on the Bank of England's website. In monitoring the impact, the MPC "will pay close attention to the growth rate of broad money, the cost and availability of corporate borrowing, measures of inflation and inflation expectations, and developments in nominal spending growth".

The broad money supply is normally measured by M4, which comprises the non-bank private sector's holdings of notes and coin and a range of sterling-denominated bank instruments including traditional deposits, CDs, securities of up to five years' original maturity, repos and bills. The aggregate has slowed so far in 2009, rising at a 10.4% annualised rate in the first five months, down from 20.1% during the second half of 2008.

M4, however, has been distorted over the last 18 months by a large increase and more recently a fall in money holdings of financial intermediaries – “intermediate other financial corporations (OFCs)” in the Bank's terminology – which mainly act as conduits for interbank business. The financial crisis resulted in banks cutting back traditional unsecured interbank lending in favour of secured forms of lending channelled through these intermediaries, facilitated by the operation of the special liquidity scheme.

The MPC is therefore focusing on an adjusted M4 measure excluding these intermediaries’ money holdings. Accurate statistics for this measure are currently compiled only on a quarterly basis but the Bank of England also makes available a “monthly proxy” based on partial information. Combining first-quarter data with proxy numbers for April and May, adjusted M4 grew by 6.8% annualised in the first five months of 2009, up from 3.0% in the second half of 2008.

This adjusted measure, however, understates liquidity growth because it omits the non-bank private sector's holdings of public-sector financial instruments that are close substitutes for "money" – these holdings have risen substantially over the last year. In particular, Treasury bills and repo borrowing by the DMO are likely to be regarded by investors as having similar characteristics to short-term bank securities and bank repos.

The chart shows annualised growth of adjusted M4 and a broader liquidity measure including holdings of Treasury bills and DMO repos. The growth rates are calculated over six months except for the final data points, which refer to January to May 2009. The broader measure rose by 10.3% annualised over this latter period – much faster than the 6.8% increase in adjusted M4.

In effect, the DMO has been operating its own liquidity creation scheme in parallel with the Bank of England’s asset purchase facility, funding the budget deficit partly by issuing Treasury bills and borrowing on repo rather than selling gilts. The non-bank private sector lent £54.2 billion in these forms in 2008-09 and the first two months of the current fiscal year – equivalent to 28% of the central government net cash requirement over the same period.

A sharp deterioration in money / liquidity trends in late 2007 and early 2008 – particularly after adjusting for inflation – warned of impending economic weakness. The recent pick-up, also more pronounced in inflation-adjusted terms, supports hopes of a recovery from late 2009. It is possible that the MPC is placing some weight on wider liquidity trends, helping to explain last week's decision to slow asset purchases and defer consideration of a rise in the £125 billion target.