MPC inflation doves argue that slower core trends in other countries support the view that the "Phillips curve" is still working. According to the June minutes, "the recent downward trends in inflation, excluding energy and food, in the United States and euro area suggested that a substantial margin of spare capacity would cause inflation to fall back in the United Kingdom too, as the impact of temporary factors wore off."

This argument, however, assumes that the observed falls in US and eurozone inflation have been caused by spare capacity. A closer examination suggests otherwise.

In the US, the annual increase in consumer prices excluding food and energy has fallen from a peak of 2.5% in August 2008 to 0.9% by June. This mainly reflects a slowdown in the "shelter" component, which has a 42% weighting in the core index. Annual inflation excluding food, energy and shelter has fallen only from 2.7% to 2.1% over this period, remaining above its average in recent years – see first chart.

The shelter component is dominated by "owners' equivalent rent" – a theoretical sum paid by home-owners to themselves in return for accommodation. Its annual rate of change has fallen from 2.5% in August 2008 to -0.2% by June, a lagged reflection of housing market weakness. It is debatable whether imputed rent should be included in a cost of living index – it is omitted from UK and eurozone indices. In any event, the decline in US shelter inflation cannot be attributed to "spare capacity" in the sense of underutilised plant and machinery or labour.

Doves retort that housing weakness cannot explain the similar slowdown in eurozone core inflation (i.e. based on the consumer price index excluding unprocessed food and energy) from an annual 2.6% to 0.9% between August 2008 and June. This decline, however, owed much to a 17% rise in the euro's effective exchange rate in the three years to July 2008 – second chart. The 12% fall in the euro since last October may be starting to lift core inflation, which bottomed at 0.75% in April.

The "big picture" is that global core inflation has proved much stickier than predicted by Keynesian models based on the large decline in output during the "great recession".

Public sector borrowing was higher than expected in June, but recent figures remain consistent with an undershoot of the Budget forecast for 2010-11.

The Office for Budget Responsibility (OBR) projects a fall in net borrowing, excluding the temporary effect of financial interventions, from £154.6 billion in 2009-10 to £149 billion this year. Attempting to adjust for seasonal factors, borrowing averaged £12.25 billion per month between April and June, or £147 billion annualised – see chart. The OBR forecast, therefore, implies no further improvement – even a small worsening – over the remainder of 2010-11.

This is unlikely because, first, the benefits of economic recovery should grow as the year progresses and, secondly, the coalition has announced spending cuts and tax rises worth £8.1 billion in 2010-11 that have yet to be reflected in the monthly numbers. Put differently, even assuming no impact from the recovery, these measures together with the recent run-rate imply borrowing of £139 billion this year (i.e. £147 billion minus £8 billion), £10 billion less than the OBR's forecast.

The forecasting approach in this journal places weight on the Friedmanite rule-of-thumb that changes in the real money supply lead demand and output by roughly six months. It is advisable to monitor the full range of money measures but narrow money, M1, has exhibited the most consistent relationship with the economic cycle historically.

The Friedmanite rule has worked well in recent years, albeit with a slightly longer lead than usual. The six-month rate of change of G7 real M1 turned negative in late 2007 ahead of the recession and bottomed in March 2008, 11 months before the six-month change in industrial output and nine months before that of the OECD G7 leading index, which is widely monitored by market participants. Real M1 expansion surged in late 2008 and early 2009, foreshadowing the strong recovery in G7 industrial activity over the last year – see first chart.

Monetary trends also signalled the current global industrial slowdown, with the six-month rise in G7 real M1 peaking as long ago as February 2009. The six-month increase in the OECD leading index reached a high eight months later in October 2009 with that of industrial output following in January 2010 – the same 11-month lag as at the cycle trough.

Importantly, however, the six-month change in real M1, while falling significantly, has remained positive in recent months, consistent with an economic slowdown rather than renewed contraction. It bottomed, moreover, in January 2010, picking up in May and, provisionally, June (the June estimate incorporates US and Japanese data only). Based on the lags at the prior two turning points, this suggests that the six-month change in the OECD leading index will bottom in September or October and that of industrial output in December.

Previous posts have explained that equities and other risk assets have, on average, performed better when real M1 has been growing more strongly than industrial output. The six-month change in real M1 crossed above that of the leading index in June, probably signalling a move above output expansion by late summer or early autumn. This could indicate an improving liquidity backdrop for markets later in 2010.

Monetary pessimists ignore M1 and emphasise recent contraction in G7 real broad money – second chart. The broad measure, however, failed to warn of the recession, continuing to grow strongly in late 2007 even as narrow money was weakening. The interpretation here is that the demand to hold broad money rose sharply as the financial crisis intensified but has been falling more recently, partly reflecting heavily-negative real deposit interest rates. Broad money, therefore, understated monetary tightness in late 2007 and is grossly overstating the degree of restriction now. Portfolio shifts are much less likely to have affected the demand for M1, which is more closely related to economic transactions.

Chinese consumer price inflation fell from an annual 3.1% to 2.9% between May and June but growth in the wider GDP deflator measure rose to 5.6% in the second quarter from 4.6% in the first – see chart. This is above the average of 4.4% since 2000.

Annual GDP deflator inflation has averaged 2.5 percentage points more than CPI inflation since 2000 but, unusually, the gap closed temporarily during the "great recession", which, apparently, bypassed China. This could reflect price weakness in non-consumption GDP components; it is also consistent with a massaging down of the deflator data in order to boost published real GDP growth rates.

Deflator inflation peaks of 8.8% in 2004 and 11.0% in 2007 followed highs of 20% and 23% respectively in annual growth in narrow money, M1 – see chart. With M1 expansion having reached 39% last year, it would be surprising if second-quarter inflation of 5.6% marks the peak in the current upswing.

Chinese monetary policy is on hold but inflationary risks from the monetary overhang suggest no scope for growth-boosting actions.

US private job openings (vacancies) slipped back in May but the three-month moving average continued to climb, suggesting a further rise in employment – see first chart. (Private-sector numbers have been used to avoid distortions caused by temporary government employment to conduct the decennial census.)

UK vacancies are also on the up again after a temporary dip in early 2010, possibly related to election uncertainty, with an increase in private openings in the three months to June offsetting a fall in the public sector – second chart. Employee jobs in the quarterly workforce survey were still falling in the first quarter but employee numbers in the (more volatile) labour force survey increased in the three months to May.

The fall in annual consumer price inflation from 3.4% in May to 3.2% in June reflects a slowdown in fuel costs. "Core" trends remain stubborn, with a recent acceleration in services inflation providing further evidence that spare capacity is failing to exert the dampening impact expected by the Monetary Policy Committee.

Other points:

• CPI inflation averaged 3.44% in the second quarter versus the Bank of England's 3.30% estimate in the May Inflation Report. This is the fifth quarter out of the last six that the Bank has underestimated current-period inflation.

• "Core" inflation excluding energy, food, alcohol and tobacco moved back up to its recent high of 3.1% from 2.9% in May.

• Core resilience reflects a pick-up in services inflation from 3.0% in January to 3.9% currently. Inflation optimists argued that services trends would slow in response to excess capacity, with a weak exchange rate having less offsetting impact than in manufacturing. The recent acceleration, however, had been suggested by business surveys – see chart.

• Goods inflation, excluding energy and food, has fallen from 3.3% to 1.9% since January, partly reflecting a stabilisation of the exchange rate. Imported pressures, however, remain strong, with manufactured import prices rising by 5% in the first five months of the year, according to May trade figures released last week.

• The Bank is likely to be forced to revise up its forecasts of 2.54% and 2.28% in the third and fourth quarters significantly in the August Inflation Report. On conservative assumptions, inflation may average 2.75% in the fourth quarter before returning to 3% in early 2011 as VAT is raised.

• The second-quarter outturn of 3.44% compares with a central projection of 0.73% a year earlier in the May 2009 Inflation Report. Bank officials have deflected criticism of this forecasting failure but an internal review may be under way, with the Bank's recent Annual Report stating that the budget contains an allowance for expenditure of £2.4 million on a "new forecasting model".