The base-case forecast here is that the global economy will regain momentum during the second half in lagged response to faster G7 real money growth since early 2011 and as Japanese supply-chain disruption unwinds. This should be signalled by a stabilisation and recovery in manufacturing surveys.

June purchasing managers’ survey results fit the story. G7 weighted-average new orders fell slightly further last month but this reflected weakness in Euroland, with US, Japanese and UK indices improving. Eurozone underperformance is consistent with lagging monetary growth discussed in previous posts.

A bottoming of G7-wide momentum is also suggested by a stabilisation of developed-market company earnings revisions – see first chart.

US manufacturing fluctuations continue to follow the pattern of previous recoveries – second chart. The cyclical template also suggests improvement, consistent with the message from monetary trends.

While global momentum is expected to revive, growth is likely to be slower than during 2009 and 2010 because of Eurozone weakness and less dynamic expansion in emerging economies, reflecting restrictive monetary policies. In contrast to the G7, E7 real narrow money growth has continued to slow recently – third chart.

A Sunday Times story claims that “fears over the strength of Britain’s recovery are growing” and “City forecasters now believe the economy will expand by as little as 0.3% between April and the end of June”. A 0.3% rise in GDP in the second quarter would actually represent a strong performance given the drag from the additional bank holiday in April.

The suggestion of a sub-par second-quarter number is not new. The Bank of England appears to have assumed an increase of only 0.3% in its last Inflation Report, prepared at the start of May. The preliminary estimate is released on 26 July.

A similar distortion to the figures last occurred in the second quarter of 2002. The usual May bank holiday was replaced by a two-day holiday in early June to celebrate the Queen’s Golden Jubilee. The Office for National Statistics (ONS) estimated that the change depressed second-quarter GDP growth by between 0.2 and 0.7 percentage points. Assuming a similar impact, a 0.3% GDP rise in the second quarter would imply underlying growth of between 0.5% and 1.0%.

A monthly GDP estimate based on output data for the services, industrial and construction sectors (99% of the economy) fell by 2.1% in April, the largest decline since a 2.2% drop in June 2002 – see chart. If GDP recovered to its March level in May and June, the quarterly rise would be 0.6%. The March reading, however, was probably inflated by catch-up activity after bad weather disruption in December and January. The suggested 0.3% second-quarter increase, therefore, looks plausible.

The holiday effect will reverse in the third quarter. In 2002, the ONS estimated that reported third-quarter GDP growth was boosted by between 0.4 and 0.7 percentage points. Assuming underlying expansion of 0.5% in the current quarter, this suggests a reported GDP increase of between 0.9% and 1.2%.

Pessimistically-biased media commentary is adding to market fears that a dovishly-inclined MPC will launch QE2, sending sterling down the slipway.

At this morning’s level of 77.5, sterling’s effective exchange rate has fallen by almost 4% since MPC member Paul Fisher decided to confide his QE2 leanings to the Daily Mail a month ago. Was this the intended result? With the short-term inflation outlook improving at the margin as global commodity price pressures abate, Mr Fisher and his fellow MPC doves may think it opportune to launch another assault on the exchange rate in pursuit of the holy grail of “rebalancing” and manufacturing resurgence.

The effective rate is rapidly closing on its 10 March trough of 76.8, below which the next obvious stopping point is the all-time low of 73.7 reached in December 2008.

A post in January argued that the MPC’s policy inaction in the face of a continued inflation upswing risked a “double dip” in sterling as real interest rates moved deeper into negative territory. A comparison was drawn with the 1970s, when the exchange rate entered a second leg down after a year-long period of stability as the inflation / interest rate gap was similarly allowed to widen.

Sterling’s recent sideways trading has lasted much longer – two and a half years – but MPC members are deluded if they think this stability would survive the launch of QE2. The chart – an update from the previous post – overlays exchange rate performance during the 1970s on recent movements and is showing ominous signs of reconnection with the earlier debacle. (The chart aligns the peak in December 1971 with July 2007, which marked the start of sterling’s first plunge. July 2011 is the equivalent of November 1975.)

Equities and other risk assets have been sensitive to shifts in central bank liquidity since the dramatic easing that followed Lehman’s collapse in September 2008. A post in early June noted that combined bank reserves at the Fed, Bank of Japan and ECB were edging higher again, implying increased support for markets.

The rise has since continued, resulting in G3 reserves reaching a new record high and helping to explain this week’s strong equity rally – see first chart. Unexpectedly, the recent increase is the result of stepped-up liquidity provision by the BoJ and ECB rather than the tail-end of QE2 in the US. The Japanese infusion may have been a response to yen strength and has succeeded, at least for now, in capping upward pressure on the currency – second chart.

The rise in ECB reserves is a reflection of a recent increase in demand for funds at the weekly refinancing operations as funding for weaker banks has dried up in response to the latest Greek crisis.

US reserves remain below their mid June level despite further QE2 operations because the Treasury has increased its cash balance at the Fed, possibly as a precautionary measure in case negotiations over raising the debt ceiling fail. The balance in the Treasury’s general account rose from $23 billion to $106 billion between 8 and 29 June. Reserves should move above the prior high as this cash is released back into the system over coming weeks.

Barring a surprise reversal of the recent BoJ and ECB injections, therefore, central bank liquidity will remain a near-term support for markets.